Académique Documents
Professionnel Documents
Culture Documents
"A biting, incisive look at corporate excesses... funny, opinionated and not shy in offering harsh moral judgement."
The Dallas Morning News
"[A ]delicious disembowling of the company.... Bryce has a rare
ability to explain complex financial concepts clearly, combined
with a breezy, colloquial style that makes his story a page
turner."
Salon.com
"While most [missteps] have been reported in some fashion in
the buckets of ink spilled on the story, Bryce still packs a punch
by gathering all the damning details in one place ... Bryce is
most compelling when he sketches the corrupt cast of characters."
BusinessWeek
"There's nothing familiar about what Robert Bryce has accomplished in this superb book ... Meticulously researched ... Bryce
presents [financial] stuff with such admirable clarity that even
the most numerically illiterate English major can grasp its gist."
Austin Chronicle
"It's a Barbarians at the Gate-type read."
Cindy Adams, New York Post
"Robert Bryce has done a brilliant job of explaining what Enron
was all about and what made it fall apart. Better still, he provides fascinating insights into the lives of the firm's executives
who were calling the s h o t s . . . a mesmerizing read."
Tulsa World
"Humorous ... entertaining and easy-to-follow.... Bryce's
account sets the bar high for other Enron books to come."
San-Jose Mercury News
"No one succeeds in telling the story like Texas journalist Robert
Bryce. His straightforward book ... is a must-read for the business set, and an enjoyable read for the rest of us."
National Post (Canada)
"Bryce, who understands the flamboyance built into Texas business culture, clarifies Enron's muddled and deceptive accounting
practices, deconstructs the bone-headed and perpetually hyped
ventures ... while lacing his account with the sexual foibles that
played a tacit part in creating the company's anything-goes executive culture ... There are sure to be many accounts of Enron's
collapse, but Bryce's gossipy version will be hard to beat for
sheer readability."
Kirkus Reviews
"Enron's downfall was inevitable, and with Bryce as chronicler,
it makes for a terrific story.... [Bryce] has mined his sources well
and also observes the important investigative rule of 'follow the
money,' revealing a systemic corporate breakdown at Enron that
was widespread, stretching from the office of the CEOs to the
board of directors to various lower-level executives and
beyond."
Library Journal
"Finally, an Enron book that actually explains what happened at
Enron ... This isn't just the first book to make sense out of the
debacle; it's a vivid cautionary tale about the consequences of the
lurid excessespersonal and professional."
Publishers Weekly
"A comprehensive piece of investigative journalism."
Booklist
Pipe
Dreams
Robert Bryce
Contents
Author's Note
Introduction by Molly Ivins
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
xI
xv
i
13
24
31
34
37
44
52
60
69
76
85
93
104
111
120
126
132
137
144
viii
CONTENTS
149
155
161
169
175
190
199
205
215
223
232
240
245
249
257
267
270
275
284
293
300
305
309
313
318
321
323
328
334
339
343
363
3 73
377
391
395
Position at Enron
Shares Sold
Gross Proceeds
J. Clifford Baxter
Robert Belfer
Norman Blake
Rick Buy
Rick Causey
Ronnie Chan
James Derrick
John Duncan
Andy Fastow
Joe Foy
Mark Frevert
Wendy Gramm
Kevin Hannon
Ken Harrison
Joe Hirko
Stan Horton
Robert Jaedicke
Steve Kean
Mark Koenig
Ken Lay
Charles LeMaistre
Rebecca Mark
Michael McConnell
Jeff McMahon
Cindy Olson
Lou Pai
Ken Rice
Jeffrey Skilling
Joe Sutton
Greg Whalley
Vice-Chairman
Member of Board of Directors
Member of Board of Directors
Chief Risk Officer
Chief Accounting Officer
Member of Board of Directors
General Counsel
Member of Board of Directors
Chief Financial Officer
Member of Board of Directors
Chief Executive Officer, Enron Europe
Member of Board of Directors
President, Enron Broadband Services
Member of Board of Directors
CEO, Enron Communications
CEO, Enron Transportation
Member of Board of Directors
Executive Vice President, Chief of Staff
Executive Vice President
Chairman, Enron Corp.
Member of Board of Directors
Chief Executive Officer, Azurix
Executive Vice President
Treasurer
Executive Vice President
CEO, Enron Energy Services
CEO, Enron Broadband Services
Chief Executive Officer, Enron Corp.
Vice-Chairman
Chief Operating Officer, Enron Corp.
6I9,898
1,065,137
Unknown
1,011,436
473,837
830,444
13,360
64,932
12.9,153
4,002,259
17,344
1,895,631
32,960
39,630
83,183
3,912,205
1,234,009
1,307,678
688,996
Unknown
$34,734,854
$111,941,200
$1,705,318
$10,656,595
$13,386,896
$337,200
$12,563,928
$2,009,700
$33,675,004
$1,639,590
$54,831,220
$278,892
Unknown
$75,416,636
$35,168,721
$47,371,361
$841,438
$5,166,414
$9,110,466
$184,494,426
$841,768
$82,536,737
$2,506,311
$2,739,226
$6,505,870
$270,276,065
$76,825,145
$70,687,199
$42,231,283
Unknown
20,788,957
$1,190,479,472
TOTALS
21,100
140,234
208,940
8,000
230,660
35,000
687,445
38,160
986,898
10,328
*A11 listed sales occurred between October 19, 1998 and November 27, 2001. The number shown under
gross proceeds indicates the number of shares times the price of Enron stock on the day the shares were
sold. It does not reflect any costs the Enron officials incurred in exercising the sale of the stock. Therefore,
the net proceeds to the listed individuals is likely less than the amount shown.
SOURCES: Mark Newby, et al. vs. Enron Corp., et al., Securities and Exchange Commission filings, Congressional testimony, Enron Corp. press releases.
Author's Note
xii
AUTHOR'S NOTE
are being sued. Some will be indicted. Most should be stripped of their
ill-gotten gains (fat chance of that) or, at a minimum, flogged in public
and sent to bed without dinner. Given those factors and the knowledge
that they'll likely be tied up in depositions and court proceedings for
the next decade, they kept quiet. The same was true for the Enron
board members, the hapless, hoodwinked Greek chorus of fat cats
many of whom had special "consulting" deals with Enronwho stood
idly by while Enron was ruined.
Since the miscreants weren't talking to me or anyone elseand I had
no interest in dealing with their spin doctors and lawyersI decided
that this would be an "outsider" book. And because I wouldn't have
access to the thought processes or conversations of the top executives, I
would rely on what was available: public records and people in the
know. I interviewed as many people as I could who knew what had happened inside Enron. As you'll see, a great majority of those peoplemany former and some current Enron employeesdid not want to be
quoted by name. Many of them still work in Houston and feared retribution. All of them want to stay out of court. But they wanted the true
story of Enron's failure to be written. So they trusted me. And though I
cannot name them, I owe them my sincere appreciation. Thanks.
I had a brigade of longtime friends and former Enron people (many
of whom have become friends) who were supportive, candid, and generous with their time. First, thanks to Lou Dubose. He challenged me
to do the book, came up with the title, got me an agent, and even
proofed my pitch. Thanks, too, to Bob Elder, another terrific reporter,
who suffered through many bad ideas and even more bad writing while
giving insightful advice. Thanks also to Robb Walsh for his hospitality,
educating me about Suite 8-F and introducing me to Houston's amazing food scene.
I also want to thank (in no particular order) Sherri Saunders, Stan
Hanks, George Strong, Chris Wasden, Ken Stott, J. Paul Oxer, Lowell
Lebermann, Dan Ryser, David and Marty Woytek, Terry Thorn, Rod
Gray, Kurt Q. Holmes, Lou Gagliardi, Art Smith, John S. Herold, Inc.,
Ron and Violet Cauthon, Susan Wadle, Carol Coale, Andrew Wheat,
AUTHOR'S NOTE
xiii
xiv
AUTHOR'S NOTE
Introduction
xvi
INTRODUCTION
INTRODUCTION
xvii
Pipe Dreams
PIPE DREAMS
There was plenty of irony in the location of the job fair. Just twenty
months earlier, Enron's CEO and chairman, Ken Lay, was on top of the
world, and that world revolved around Enron Field.
April 7, 2000, was undoubtedly one of the best days of his entire
life. That day, Enron Field opened for business, and the Houston Astros
hosted the Philadelphia Phillies in the first game ever played at the new
$265-million retractable-roof baseball stadium. Lay threw out the ceremonial first pitch. Then he moved to his private box and watched the
game with his friend George W. Bush, governor of Texas, already the
odds-on favorite to become the next president of the United States. In
addition to having Bush's ear, Lay had one of the biggest plums associated with the Bush orbit: a nickname.
Yes, George W. Bush, the man-who-would-be-president, had
slapped Lay with the moniker "Kenny Boy." It wasn't exactly on a par
PIPE DREAMS
PIPE DREAMS
banking work by Enron, were happy to put out "strong buys" on the
company's stock.
Enron is the biggest derivatives-trading firm to go bust since the failure of the hedge fund Long-Term Capital Management in 1998. LongTerm, led by a pair of Nobel Prize-winning economists, made huge bets
using predictive models based on statistical analysis. The firm lost some
$4.6 billion trading derivatives, the complex financial instruments that
include futures, forwards options, and swaps. The firm's positions
involved so many banks that the New York Federal Reserve organized
a multibank, $3.6 billion bailout, lest Long-Term's failure cause a
global financial meltdown. And though Long-Term was big, Frank
Partnoy, a law professor at the University of San Diego, told Congress
in January zooz, that Enron's derivatives business made Long-Term
"look like a lemonade stand."3
That's a bit of hyperbole, but there's truth in it, too. In 2000, if
Enron's derivatives business had been a stand-alone Fortune 500 company, it would have been the 256th-largest company in America. That
year, Enron claimed that it made more money from its derivatives business$7.23 billionthan Tyson Foods made from selling chicken. By
the time Enron failed, its derivatives liabilities exceeded $18.7 billion, an
exposure that played a key role in pushing the company into bankruptcy.
In addition to the hugely complex derivatives transactions Enron
was making with other big energy firms and utilities outside of Enron,
it was making mind-numbingly complex derivatives deals inside of
Enron with Andy Fastow's off-the-balance-sheet partnerships. Those
derivatives dealsall completely unregulated by federal authorities and
kept secret from investors fatally corrupted Enron's books. By the
time investors learned the size and scope of Enron's derivatives deals
with Fastow, on February 1, 2002, with the release of the report by
William Powers, dean of the University of Texas Law School, Enron
had already failed.
It's the biggest scandal to ever hit accounting, the world's secondoldest profession. The once-great accounting firm Arthur Andersen
wasn't just in bed with Enron, the venerable firm was providing the
PIPE DREAMS
It's a simple question: Why did it? Whyover a period of four yearsdid Enron go from thriving and stable to insolvent? Why did a seventysix-year-old pipeline company with rock-solid cash flow and reliable
earnings suddenly flame out in a maelstrom of accounting irregularities, fraud, and skullduggery?
10
PIPE DREAMS
me any details about his job at Enron. Joe had the ultimate I-wouldn'tcross-the-street-to-piss-on-you-if-your-brains-were-on-fire attitude.
But Joe said one thing that rang true: "Enron is not an operations
company. It is a deal company." A few minutes later, Joe glanced at his
$1,400 designer watch and made it clear that he had far more important things to do than talk to dolts like me. So we walked out to his
cara brand new Lexushe slipped his folding cell phone into his
handy belt holster, and off he sped. I would later learn from his
coworkers that Joe was considered a very successful Enron employee.
In fact, he was the exact type that Enron recruiters loved: young (Joe
was thirty-five, tops), smart, and cocky. That didn't mean his coworkers liked him. They thought he was a world-class jerk. But in Enron's
view of the universe, he was successful.
A few days later, I realized that I owed Joe a thank-you. His comment about Enron being a deal company was proving to be right on the
money. So I rang him up.
He didn't return my phone call.
But that didn't matter. Even though Joe really didn't want to help,
he had unwittingly done me a great service. He reminded me that being
a Texas-sized sphincter was valued at Enron and that dealsand therefore, deal makers like himwere prized. Enron's headquarters at 1400
Smith Street in downtown Houston had overflowed with young Masters of the Universe just like him. But having a surfeit of sphincters
didn't explain it. So I continued collecting theories.
Jack Bowen, the former CEO of pipeline giant Transco Energy (now
part of Williams Companies), had his own theory, and having given
Ken Lay his first job in the pipeline business in 1974, Bowen was in a
position to know. The problem at Enron, according to Bowen, was that
it paid its employees too much. "They went way overboard in compensation of their top executives," he said. "They had huge stock options
based on the price of stock, and price of stock is based on the earnings
they report. So there was tremendous incentive on the part of key people to keep those earnings growing. As earnings went up, their options
were worth that much more. You can get too much money."
11
Bowen was clearly right, too. The top executives were making enormous salaries at Enron, far more than executives at comparable firms
in Houston. Plus, Enron was handing out stock options to top executives and lower-level employees all the time. By the end of 2.000, over
13 percent of all of Enron's outstanding stock was held in options.
Those options were going to make everyone at the company rich, that
is, if Enron could just keep impressing Wall Street with big profits.
There were plenty of other theories. A Wall Street analyst said the
sexual shenanigans of the top executives could not be discounted. It
was well known that Enron president Jeff Skilling had cheated on his
wife for years before divorcing her. Other top execs, including Ken Lay,
Ken Rice, Lou Pai, and others, had also been involved in adulterous
affairs. That raised a red flag among some observers on Wall Street,
particularly those who loathed Skilling and his arrogance. "If character
has become an issue, then these are important notes to make about a
man. This is a guy who felt he could get away with anything," the analyst commented.
One former top executive blamed the company's aggressive accounting. The company's use of mark-to-market accounting had corrupted
Enron's books and had allowed the company to be far too optimistic in
its assumptions about future profits. That meant, said the executive,
who had worked at both Enron and Azurix, Enron's failed water venture, that Enron could show huge revenue growth but have little or no
cashreal moneywith which to pay its debts. "When earnings go up
and cash flow goes down, you can't sustain that. Sooner or later the
laws of physics apply," he said.
A former military man who'd spent several years at Enronnumerous West Point graduates worked in Enron's international operations
cut me off at the get-go. "Either you acknowledge that this is all about
Ken Lay or we don't have much to talk about," he told me, approximately two and a half minutes after I introduced myself. "This guy was
the head of this company for all but six months for the period from
1986 to December 2., 2001. Whether it's willful misconduct or arrogant indifference doesn't matter," he said. "I come from a military
12
PIPE DREAMS
14
PIPE DREAMS
15
which every resident is hoping to escape. Most don't. And the crushing
poverty evident on the fringes of downtown are a constant counterpoint to the amazing wealth and opulence of the city's West Side, where
tanned, toned women dressed in expensive clothes and driving shiny
SUVs shop aimlessly for knickknacks at stores like Neiman Marcus and
Smith & Hawken. Houston has a sprawling, strip-mall sameness that
makes it seem the city and its suburbs never end. The flatness of the
landscape and the lack of significant natural landmarks are so disorienting that drivers must pay close attention to traffic signs on the freeway or they might accidentally end up in Sugar Land when they meant
to go to Galveston. The sameness is made worse by the lack of zoning
laws. Except for a few regulations on fireworks warehouses and sexually oriented business, Houston has no zoning laws. Never has. So you
can have a bakery next to a church, next to a high-rise office building,
next to an auto salvage yard. The lack of regulation has created a city
that has "pockets of civilization surrounded by chaos," as one former
city council member described it. "That doesn't make Houston special,
it makes Houston a mess."
To be fair, Houston has a tremendous number of attractions. It's one
of the most ethnically diverse cities in America. It will soon have no distinct majority. Instead, it'll have one-third Anglos, one-third Hispanics,
and one-third everybody else. That everybody else includes a huge
Asian population. Its Asian markets on the far western side of town are
nothing short of amazing. Every type of live fish, squid, eel, and octopus is available for purchase, along with dozens of exotic teas and
herbs from the Far East. The people are invariably friendly. The city's
theater district is world class. The Houston Ballet is world class. The de
Menil Art Museum, designed by Renzo Piano, is way cool (the collection isn't bad, either). The Rothko Chapel is sublime. Houston has a
world-class opera company, along with a clutch of fine art and science
museums. Its Texas Medical Center is one of the biggest and most opulent medical facilities in the world. It has one of the world's biggest
space installations at the Johnson Space Center.
16
PIPE DREAMS
17
dream Big Dreams and are willing to make Big Betspeople like John
Henry Kirby.
The gusher at Spindletop clouded John Henry Kir by's judgment. Kirby,
a timberman who'd spent virtually his entire life in the remote, heavily
wooded counties of East Texas, had gotten ahead by selling lumber and
building railroads. He knew nothing about the energy business. But
when Spindletop blew in on January 10, 1901, Kirbyalong with
thousands of other speculatorswas bitten by the oil bug. Spindletop,
located in Jefferson County, a few dozen miles east of Houston, was the
gusher to end all gushers. The well, drilled by a former captain in the
Austrian navy named Anthony F. Lucas, erupted in a volcano of oil,
blowing a stream of crude 100 feet into the air.4 The roar from the well
was so intense it could be heard four miles away in downtown Beaumont. The well flowed uncontrolled for nine days, pushing out a river
of oil with estimated production of up to 100,000 barrels a day.
Within days of the discovery, Spindletop and nearly all of Houston
was in chaos. Throngs of sight-seers, promoters, speculators, and merchants descended on Beaumont to take part in the new gold rush. One
Sunday shortly after the well came in, 15,000 sightseers came on excursion trains just to see the well. Land prices shot through the stratosphere. Land that two years earlier had been selling for $10 per acre
was suddenly selling for as much as $900,000 per acre. Within months
of the discovery, Beaumont's population soared from 10,000 to
50,000 about one-third of the newcomers living in tents. More than
2,00 wells, owned by over 100 different oil companies, were soon
drilled on the same hill as the Lucas 1.
The Texas oil boom had begun, and John Henry Kirby was going to
be a part of it.
Kirby was born in 1860 near Peach Tree Village, in Tyler County,
Texas, in the heart of what is now known as the Big Thicket. His
mother taught him to read and writehis formal schooling consisted of
occasional visits to local schools and less than one semester at South-
18
PIPE DREAMS
19
20
PIPE DREAMS
21
The house is the most visible part of Kirby's legacy. But it's also
clear that without Kirby's gamble, the Texas energy business would
have taken a far different path. As a Kirby biographer wrote, "without
his bold enterprise, there might never have been a Houston Natural
Gas Corporation."9
Although John Henry Kirby was no longer affiliated with Houston Oil
Company, the money that he paid the firm following the 1908 settlement agreement allowed it to continue its exploration activities. In the
early 1920s, the company discovered vast gas fields in Live Oak and
Refugio Counties. And though the discovery was fortuitous, it also
forced the company to make some difficult choices. Up to that time,
more that 90 percent of Houston Oil's revenues came from oil, not gas.
For years, prospectors had viewed natural gas as a problem, not a
profit center. Most gas was vented into the air or burned off in flares.
Gas was harder to handle and transport than crude oil and had far
fewer uses. One of its main uses during the late iSoos and early 1900s
was for lighting. It was also gaining favor in industrial applications like
steelmaking, but limited infrastructure constrained its consumption.10
Further, it had a nasty habit of exploding when treated improperly. By
comparison, crude oil was not as flammable and could be refined into
fuel that could be used for automobiles, heavy equipment, generators,
heating, cooking, and lighting.
The first gas pipeline was built in the late iSoos in New York state
to carry gas from West Bloomfield to Rochester. It was twenty-five
miles long and about one foot in diameter. But it was limited in value
because, being made of hollowed-out pine logs,11 it leaked like a sieve.
The first significant high-pressure gas pipeline was built in 1891 by
Indiana Gas and Oil company, which installed a izo-mile-long pipeline
from a gas field in Indiana to customers in Chicago. But that pipe, too,
was riddled with leaks, and by 1907 was shut down; Chicago consumers reverted to using coal gas. For the next few years, urban gas
systems were unreliable and expensive.
22
PIPE DREAMS
23
tled over the right to serve the city. But Houston Natural Gas (HNG)
was finally able to win a concession from the city. Within fifteen
months of completing the pipeline from Live Oak County to the city's
outskirts, the company had laid pipe to hundreds of homes in the city.
And it was able to undercut the prices of its major competitor, the coal
gas company.
Over the next few decades, Houston Natural Gas expanded rapidly,
its growth fueled by the Houston area's astounding growth. The
region's population more than doubled every twenty years between
1900 and 1980. In 1920, Harris County had 186,667 residents. By
1980, that figure was 2.4 million.13 In 1976, Houston Natural Gas sold
its retail gas operation, which provided gas to residential customers in
Houston, and began focusing on natural gas production and other
businesses. And it was doing very well.
By 1975, HNG owned over 300 gas wells and 97 oil wells in Texas,
Oklahoma, New Mexico, West Virginia, and Wyoming, containing 356
billion cubic feet of gas and over 2.5 million barrels of oil. It owned
coal mines, natural gas gathering systems, natural gas liquids extraction
plants, river barges, and thousands of miles of pipelines, both onshore
and offshore.14 By the early 1980s, HNG was one of the most profitable companies in Houston. In 1984, it had over $3.7 billion in assets.
Revenues topped $2 billion and profits were $123 million.15
That success caught the eye of a hometown Houston millionaire
energy speculator and corporate raider named Oscar Wyatt. His greed
was to provide Ken Lay with one of the biggest breaks of his career.
Buy or Be Bought
Oscar Wyatt was just plain mean. He was the kind of guy who'd sue
his own brother-in-law. In fact, he did just that. Three times.1
Never mind that his brother-in-law, Robert Sakowitz, had already
been forced to take the family's Sakowitz department stores into bankruptcy in 1985 and that the business that his grandparents had founded
nearly a century earlier had left him nearly broke. Wyatt and his
socialite wife, Lynn, wanted to humiliate Robert Sakowitz, so they sued
him over his management of the family's business affairs and got an
out-of-court settlement. Wyatt was so much like the caricature of the
brash, larger-than-life Texas oilman that when a Houston Chronicle
story quoted a citizen who likened Wyatt to J. R. Ewing, the duplicitous villain of the television series Dallas, Wyatt sued the paperand
got a settlement for that, too.2
Not that Wyatt needed the money. By the time he sued his brotherin-law, he was, as they say in Texas, Big Rich. But fighting was in
Wyatt's blood. As the founder of Coastal Corporation, he'd grown rich
by targeting undervalued oil and gas assets, buying them on the cheap,
and selling them for immense profits. He was a devout profiteer and
hated losing money, ever. If that meant cutting off gas to businesses and
schools in some of the state's biggest cities, as he did during the
BUY OR BE BOUGHT
25
1970s even though he was obligated to deliver the gas then Wyatt
would cut them off and deal with the consequences. As he explained to
one reporter in 1985, "As a corporate manager you have to have one
objectiveto be profitable or popular. I've chosen to be profitable."
By the early 19805, Wyatt was hungry for acquisitions and HNG
was a natural target. Coastal had oil wells, pipelines, and refineries, and
HNG's distribution assets were an almost ideal fit with Wyatt's plans to
grow his company. At the time, Coastal, with $5.8 billion in annual revenue, was nearly twice as big as HNG. Even better, HNG had little debt,
so Wyatt could use HNG's strong credit rating to borrow the money
he'd need to do the takeover. So in January of 1984, Coastal launched a
$1.3 billion takeover bid for HNG. Although Wyatt had made a hostile
takeover bid for another company called Texas Gas Resources just a few
months earlier, HNG's leadership was caught completely off-guard. "It
was a total surprise," said one longtime HNG executive. "It showed up
as an ad in the Wall Street Journal one day. Wyatt said, 'I'm offering to
buy 51 percent of the stock of HNG.'" The offer sent tremors through
HNG's headquarters, and the company's leaders were completely unprepared for a proxy fight. "At that time, Wyatt was generally considered a
thug," said the former executive. "And nobody in the company wanted
to be in business with him. So we were going to do all we could not to
fall into the hands of Oscar Wyatt."
To avoid Wyatt, who already held 5 percent of HNG's stock, HNG
made a counteroffer to Coastal shareholders, saying it would buy
Coastal for $50 a share, in a deal valued at $1.1 billion. HNG's board
also approved an unusual defense, saying it would offer its own shareholders $69 per share for their stock (Wyatt had offered $68 a share) in
an effort to acquire 8 million shares of the company. A stock buyback
would have allowed HNG to fend off Coastal's offer because it would
have prevented Wyatt from gaining a majority of the outstanding
shares in the company. The HNG board members also started looking
for legal maneuvers that would help them escape from Wyatt. They
found one in a 1979 settlement between the state and Coastal that was
designed to prohibited Wyatt's company from exerting too much power
26
PIPE DREAMS
in the Texas natural gas market. HNG convinced then Texas attorney
general Jim Mattox to file a lawsuit against Coastal, and Wyatt's bid to
take over HNG was stopped.
But the Coastal takeover attempt was still costly. HNG had to pay
Wyatt $42. million in "greenmail" to go away. And HNG was still vulnerable. Other corporate raiders such as Irwin Jacobs were lurking.
Wyatt's bid had also convinced the company's board that HNG's CEO,
M. D. Matthews, was not a strong enough leader. "There wasn't anything evil about him, but he was a weak CEO," said an executive who
was at HNG at the time. "He's not the kind of guy you need when you
are fighting a hostile takeover." The members of the board knew they
needed someone more dynamic than Matthews, and after a short discussion, they agreed to quietly approach an executive at another
pipeline companyKen Lay.
HNG's board members met Lay while they were searching for a
"white knight" who could save them from Wyatt. At the time, Lay was
working for Transco Energy, a pipeline company based in Houston that
delivered gas to several states in the Northeast. Transco was big enough
to merge with HNG, and their pipelines would have been complementary. During their discussions with Transco, the HNG board members
met with both Jack Bowen, the company's CEO, and Lay, who was
serving as president and chief operating officer. Bowen recalled that
Transco was nearly ready to do a merger with HNG when Mattox
intervened and sued Coastal. "So HNG didn't need us anymore," said
Bowen. "But the board of HNG had become impressed with Ken Lay."
Within a few weeks, Lay was named chairman and CEO of HNG.
Finally, Ken Lay had the job he'd been wanting for decades. At HNG,
instead of answering to others, he'd be in charge. For a child from
miniscule Tyrone, Missouri, the ascent to the executive suite was both
improbable and, somehow, almost inevitable.
Kenneth Lee Lay was born on April 15, 1942 to a hard-luck farmer
and erstwhile Baptist preacher, Omer Lay, and his wife, Ruth. Omer
BUY OR BE BOUGHT
27
Lay was uneducated but hardworking, a man who had held a number
of jobs ranging from selling farm implements to working in a department store. Lay's older sister, Bonnie, recalled that Omer always had
"two or three jobs to support the family." And charity was always a
priority. The family often opened its doors to transients who rode
freight trains through town.
From an early age, Ken, who was one of three children, dreamed of
being in business. "I spent a lot of time on a tractor and had a lot of
time to think," he told one interviewer. "I must confess, I was enamored with business and industry. It was so different from the world in
which I was living."
In 1958, when Ken was still in high school, the family moved to
Columbia, so he and his younger sister, Sharon, could attend the University of Missouri. That was where Ken Lay met the man who would
become his mentor and provide the springboard into public service,
economist Pinkney Walker, Lay began taking nearly every economics
class that Walker taught. As Walker remembered, Lay was a "straightA student." He was also a member of the Beta Theta Pi fraternity, a
group renowned for its scholars and jocks, and became president as a
junior, an unusual accomplishment in the Greek system, where seniority is highly prized. In 1964, Lay graduated from the university as a Phi
Beta Kappa in economics. When Lay was preparing to leave school for
the workaday world, Walker was able to convince him to continue his
studies. Walker found Lay a part-time university job that paid enough
to live on while he finished his master's degree. In 1965, with his master's in hand, Lay went to work as an economist for Humble Oil in
Houston. Then in 1968, at the height of the Vietnam War, in order to
meet his deferred service requirement, Lay entered the U.S. Navy Officer Candidate School. He expected to work at a supply post, but
Walker again intervened and got Lay assigned to the Pentagon, where
his task was to come up with a better military purchasing system.
Although the war was raging and the Pentagon had plenty of other
matters to deal with, Lay was able to convince his superior officers that
he should be working on his doctorate in economics.
28
PIPE DREAMS
BUY OR BE BOUGHT
29
about two years. During a hearing regarding offshore lease rights for
oil drilling off the coast of Florida, Lay met Jack Bowen, the CEO of
Florida Gas. In late 1973, Lay wrote Bowen and asked him for a job.
The two later met privately in Washington to discuss Lay's position.
Bowen invited Lay to visit Winter Park, where Florida Gas had its
headquarters. "He brought his wife, Judie, down and they liked it, and
he came down. He went to work right after the first of the year in
1974," says Bowen.
One of Lay's jobs at Florida Gas was managing governmental
affairs in Washington, a job he was naturally suited for, given his six
years of work there. Lay rose through the ranks at Florida Gas, in
Bowen's opinion, because "he was intelligent. He had a good way with
people. Everybody liked him. He made a good impression. I could send
him off to do something and I didn't have to worry about him making
mistakes. He had good judgment." A few years later, Bowen left
Florida Gas to take a job at Transco Energy, a much bigger pipeline
company based in Houston. Lay stayed behind and rose to president at
Florida Gas.
Although Lay's professional life was going very well, his personal
life was becoming chaotic. Sometime in the late 19703, he began having
an affair with his then secretary, an assertive (some people close to Lay
call her pushy) woman named Linda Phillips. According to executives
who knew Lay at the time, his desire to make a clean break with Judie
and start a new life with Linda was a major factor behind his next
career move. And as he had done before when he was considering a
career switch, Lay called Jack Bowen.
Bowen recalled that in late 1980 or early 1981, Lay called him and
said he was "having some domestic problems. He and his wife were
getting separated." So Bowen hired him again, naming Lay the president and chief operating officer at Transco.3 Lay would stay at Transco
for three years.
But before Lay moved to Houston, he arranged for Linda to get a
job in Florida Gas's Houston office, so she could discreetly move out
there with him. "The divorce was finalized the day Lay left Florida for
30
PIPE DREAMS
Houston," said an executive who worked closely with Lay. "I remember him getting on the plane for Houston. He went straight there and
bought an engagement ring for Linda." They married shortly thereafter.
Many executives have affairs, and many get divorced. But Lay's inoffice romance may have been the worst-kept secret in Houston. As one
source close to Lay commented, "There wasn't anyone in Houston who
wasn't aware that Ken and Judie Lay were divorced while Linda had
been his secretary in Florida." The source went on to say that in recent
years, Lay's efforts to keep both Linda and Judie happy has bordered
on the bizarre. Although he dumped Judie for Linda, he continued to
invite and pay for his ex-wife and their two children, Mark and
Elizabeth, to come on family vacations. Call it a Mormon-style holiday
for a Missouri Baptist. According to the source, Ken and Linda would
stay with her three children, Robin, David, and Beau in one location. In
a nearby house or hotel, he'd install Judie and the other two kids. It
was a chance for Ken Lay to show the world that his was just one big
happy family.
Whatever the cost, Ken Lay made sure the family vacations were
peaceful and that both wives had whatever they needed. Lay's efforts to
keep his burgeoning family happy and give them lots of money was to
become the template for his management style at Enron. Just as Lay
could notor would notmake a clean break with Judie, he became
incapable of firing executives at Enron for bad decisions or poor performance. He avoided confrontations and sought to smooth over any
personnel clashes in upper management. "Ken never was able or willing to deal with problem people," said one high-ranking executive who
worked with Lay for more than a decade. "He was never willing to give
anybody constructive criticism or feedback. He could give praise and
stroke them but he couldn't kick their ass or fire them. He blindly
trusted people."
Lay's weak management skills might not have been deadly to Enron.
But his weakness was exacerbated by his dalliance with Linda. Indeed,
his marriage to Linda would help define Enron's culture.
The Merger
Ken Lay had only been on the job at Houston Natural Gas for a few
months when he got a call from Sam Segnar, the chairman and CEO at
the Omaha-based pipeline company InterNorth. Segnar was in a hurry.
Irwin Jacobs, a Minneapolis-based corporate raider, had amassed a 5percent stake in InterNorth. He was looking to make a quick profit,
just as Oscar Wyatt had done with Houston Natural Gas a few months
earlier. Segnar did not want his company to be taken over by Jacobs.
Would Lay be interested in merging the two companies?
It was an intriguing possibility. InterNorth owned one of the best
pipelines in America. It connected gas fields in Texas and Oklahoma
with cities in the Midwest and extended north to gas fields in Canada. In
the months after coming to HNG, Lay had overseen the purchase of two
big pipeline systems, the Transwestern pipeline and the Florida Gas
pipeline, moves that allowed HNG's pipes to extend from coast to coast.
With InterNorth's pipes, the combined company would have 37,000
miles of pipe that would stretch from coast to coast and border to border. Also, InterNorth was a huge company. With $7.5 billion in revenues
in 1984, it was more than three times the size of HNG. It had 10,000
employees, more than three times more than HNG, and it had a panoply
of other valuable assets, including coal mines, a natural gas exploration
32
PIPE DREAMS
THE MERGER
33
Omaha. End of story. Those InterNorth folks could whine all they
wanted, but Lay had finally gained control of the board and no selfrespecting energy company would be located in Omaha. Houston was
the place to be in the energy business. Lay had firm control of Enron,
and he could see that Enron's businesses were looking pretty good. The
exploration and production business was doing better than it ever had.
The pipeline business, while growing slowly, was growing and profitable, and Enron was transporting about 15 percent of all the gas
burned in the entire country. The company's forays into independent
power generation were gearing up, which meant Enron could potentially make money in electricity and find new markets for its surplus
natural gas.
There were still problems, of course. Enron's debt level was way too
high. The InterNorth team had agreed to take on debt in order to facilitate the merger with HNG. Lay was slowly working the debt down,
but with a total debt of $4.3 billion, the company was in constant danger of default, particularly if interest rates went up again. Furthermore,
Lay and Segnar had made a critical error when they did the merger:
They didn't entice Jacobs to sell his stock. So just seventeen months
after the two companies combined forces, Lay was forced to pay
through the nose to make Jacobs go away. The total greenmail payout
was $357 millionall of it in cash that Lay sorely needed to pay down
Enron's debt.
Nevertheless, things looked pretty good. "I'm having a lot of fun
with this," Lay told one reporter at the time. Ken and Linda Lay were
having so much fun they decided to move uptown.
If you are Big Rich or Big Important and you live in Houston, you live
in River Oaks.
It's one of the rules. It's been that way for decades, and everyone in
Houston accepts it in the same way they accept smog, traffic jams, and
the sun coming up in the East. And by January 1986, Ken Lay fit the
description of Big Important. The uproar over the merger was continuing, but Lay was CEO of the new company, and because the integration
of the two companies was going so poorly, the board agreed to make
Lay the chairman of the board, too.
So he and Linda needed a house that would reflect his upwardly
mobile status. After a bit of looking, they decided that the house for
them was 3195 In wood, a plush home in the heart of River Oaks that
had belonged to Robert Herring, the late CEO of HNG. Herring, who
headed HNG from 1967 to 1981, and his glamorous former TV-talking-head wife, Joanne, had made international relationships their business. In an effort to gain access to Arab oil and gas reserves, the
Herrings had entertained dozens of foreign dignitaries at 3195 Inwood.
Their parties included such guests as King Hussein of Jordan, Prince
Saud of Saudi Arabia, Saudi oil minister Sheik Ahmed Zaki Yamani,
35
and for good measure, the Herrings would invite the kings of Sweden
and Morocco and perhaps a Pakistani diplomat or two.1
Ken and Linda Lay were not only going to assume the Herrings'
social and business position in Houston, they were going to be sleeping
in their bedroom.
Ken Lay was only following tradition. Houston's energy barons
have always lived in River Oaks. Ever since the 1920s, when a group of
wealthy Houstonians decided they needed a "country place" away
from the city, River Oaks and the exclusive River Oaks Country Club
around which the subdivision is built have been the redoubt of the richest, most politically connected families in Houston. "It is," said longtime Houston journalist Ray Miller, "our Beverly Hills."2
More than just chic, quiet, clean, and safe, River Oaks is blessed
with good geography. Whereas lesser executives commute an hour or
more each way from suburbs like Kingwood, Katy, and The Woodlands, the Big Shots who live in River Oaks can be through a half dozen
stoplights and downtown in less than ten minutes via Allen Parkway
proof of the luxury of location in Houston.
A River Oaks address complete with what one reporter called its
"Ralph-Lauren-meets-Scarlett-O'Hara architecture" comes with certain
perks and rules. Although it's part of the city of Houston, the twosquare-mile area has its own security patrol and its own public areas.3
The rules include a prohibition on "For Sale" signs. Too gauche. Anyone buying real estate in the area must find it through a realtor or
advertisement. The prohibition on signs extends back to 1926, when
the area's original developers put deed restrictions on every house in
River Oaks. The rules included no hospitals, no duplexes, no apartments, no livestock, and of course, only Caucasian owners.4 That last
rule has, presumably, been rescinded. But the only black or brown faces
one is likely to see today in River Oaks belong to the men trimming the
grass and tending the well-watered gardens or to the women working
as maids or nannies.
At one time, more than one-fifth of the 1,600 homes in River Oaks
36
PIPE DREAMS
were occupied by energy industry folks who were not ashamed of making a big show. Billionaire oil tycoon (and bigamist) H. L. Hunt kept
one of his three families in a River Oaks home.5 An oil heiress named
Loraine McMurrey became famous for her parties, at which bagpipers
invariably greeted her guests, then accompanied them to the foyer,
where they were shown tables groaning with mounds of caviar three
feet high. A wildcatter named Jim West allegedly kept sacks of silver
dollars in the basement of his River Oaks house. When he left, he'd fill
the pockets of his jackets with coins that he'd toss to ordinary citizens
he'd see on the street.6 Former Texas governor (treasury secretary under
Nixon and one-time presidential candidate) John Connally had lived
there.
Lay's former foe, Oscar Wyatt, the head of Coastal, whose bid for
Houston Natural Gas had resulted in HNG hiring Ken Lay as its CEO,
lived in River Oaks, too. Lay's new home would be just down the street
from Wyatt's house. In fact, Wyatt was living in the home for the reigning king of Houston's Energy Alley. Wyatt owned the old Cullen Mansion, the house at 1620 River Oaks Boulevard that had been occupied
for many years by conservative wildcatter Hugh Roy Cullen, who went
on to become one of Houston's most revered philanthropists. The house
was built in 1929 and was the most prestigious address in River Oaks.
With his new home in River Oaks, Ken Lay was going to belong. He
and Linda were the heirs to the type of social and political world that
Robert and Joanne Herring had known. As the head of Enron, Ken and
Linda would be the talk of Houston. They would be attending the right
parties, hobnobbing with diplomats, politicians, and their new Big Rich
neighbors. River Oaks was going to be their launching pad.
And with the Lays in River Oaks, other Enron employees would
surely follow. Like the Lays, those Enroners would be eager for the
money, status, and class that came with a berth in Houston's most prestigious neighborhood. But an obstacle was looming for Ken Lay that
would threaten everything he had worked for, an obstacle called Valhalla.
Ken Lay was traveling in Europe in early October 1987 when he got an
urgent call from Enron's president, John M. (Mick) Seidl. The news
was bad. Real bad. And it shouldn't be discussed over the phone. The
two arranged to meet hours later in Gander, Newfoundland, the midway refueling point for small jets flying from Houston to Europe.
When the two finally met, Seidl's message was simple: "We're broke."
There'd been one part of the InterNorth deal that Ken Lay hadn't
paid close attention to. InterNorth maintained a small oil-trading business in Valhalla, New York. The purpose of the businesscalled Enron
Oilwas to speculate in crude oil and refined products. But by ignoring the business, Lay was about to pay a heavy price. A group of unsupervised traders had exceeded their trading limits and were now upside
down on contracts that required them to deliver tens of millions of barrels of crude oil oil that Enron didn't have, couldn't afford, and
couldn't deliver.
The Valhalla office had about forty people and was headed by a
trader named Louis Borget. Executives in Houston tried to keep tabs
on the Valhalla office, but it was far away, and since Borget and his
traders claimed that they were making money, Lay and his team left
them alone.
38
PIPE DREAMS
The lack of oversight had allowed Borget to get a taste of the good
life, and pretty soon he wanted more. Sometime in 1985, Borget, along
with Enron Oil's treasurer, Thomas Mastroeni, and several others
began manipulating the company's books.1 The crew set up a series of
sham corporations in Panama, which they used to create phony transactions. The phony companies helped Borget show Enron that he was
making money and led to substantial bonuses. In 1985, Borget, Mastroeni, and several others split bonuses totaling $3.1 million. In 1986,
they shared bonuses of $9.4 million.2
To hide their chicanery, Borget and Mastroeni kept two sets of
books. According to Mike Muckleroy, who headed Enron's liquid fuels
(propane, butane, and so on) business at that time, and an auditor who
worked on the Valhalla mess, one set of booksthe crooked oneswas fabricated to mislead the auditors from Arthur Andersen and
Enron. The other set of booksthe real oneswere known only to
Borget, Mastroeni, and a few others.
Borget's scam started to unravel in January 1987, when a bank in
New York called David Woytek, an Enron internal auditor in Houston,
and asked about several large payments from Enron Oil's accounts
totaling $z.i millionthat were being deposited into Mastroeni's personal account. Woytek became suspicious and began looking into the
matter. A few weeks later, Borget and Mastroeni met with Lay and a
few other Enron officials to talk about the suspicious deals. The two
traders assured Lay that nothing illicit was being done. Instead, they
claimed they were trying to shift some of their profits. They claimed
that they had met their targets for 1986 and were just trying to shift
some of that money to another month in case they had a shortfall.
Accountants call that type of maneuver "cookie-jar earnings," and it's
not only unethical, it's illegal. In addition, Woytek and the other auditors had found that Borget and Mastroeni had falsified bank statements
in an effort to hide several unauthorized payments. But Lay and Seidl
had ignored those misdeeds and allowed Borget and Mastroeni to go
back to work. They dispatched a team of Enron auditors to Valhalla to
do some further investigation, but the auditors were stymied by the
false set of books that Borget and Mastroeni showed them.
39
40
PIPE DREAMS
thought, could be handled with a few management changes. His solution was to implement new controls on Borget and Mastroeni that, in
theory, would prevent them from getting out of hand. Those controls
included moving cash control for the Valhalla operation to Houston
and removing some of Mastroeni's duties. Everything else would continue pretty much as before.
But it appears that Borget wasn't ready to return to things as they
were before. Instead, he may have been under even greater pressure to
produce profits for Enron, since the profits from earlier years had been
inflated. By mid-1987, he was on the wrong side of the crude oil market, and every time he tried to remedy his predicament, it got worse. In
trader parlance, he kept "doubling down," that is, increasing his position, hoping that he could work his way out of the hole. But an unusually volatile market kept working against him. The Iranians and the
Iraqis were still shooting at each other. Their long-running war was creating havoc in the oil markets; traders were constantly worried that an
oil tanker might be sabotaged and sink in the Strait of Hormuz, cutting
off tanker traffic to the Persian Gulf. "Every time he went long, the
price went down and every time he went short, the price went up," one
Enron official recalled.
By the time Seidl met Lay in Gander, word was leaking out that things
were seriously wrong at Enron Oil. Neither Lay nor Seidl knew the
extent of the damage because no one in Houston had been able to
examine the trading books at the Valhalla office. The best guesses put
the damage at about 50 million barrels of oilmeaning that Enron had
a liability of $850 million that it would have to meet in less than sixty
days. The probability of that was so low it was almost laughable.
Enron's credit rating was already wobbly, and once the banks got word
of the company's position, they would eliminate Enron's lines of credit
altogether. Any efforts to cover the crude oil shortfall would have to be
made quickly, and very quietly.
Lay didn't have many choices. He dispatched Mike Muckleroy, who
41
42
PIPE DREAMS
achieved Muckleroy's goal, which was to give the major oil companies
and trading houses the impression that Enron had been able to cover its
short position. Over the next two weeks, Muckleroy gradually
unwound all of Borget's positions. "Muckleroy and his team saved the
company," said Woytek.
Although the public was never told just how bad the Enron Oil situation was, the company was forced to disclose the fiasco. And in October 1987, Enron announced it would take an $85-million charge
against earnings in the third quarter. Lay told the New York Times the
incident was an "expensive embarrassment." 3 He told another paper
that it "confirms that oil trading is a very volatile, very risky business. I
would not want anyone to think at any time in the future this kind of
activity would affect our other businesses. It is the only kind of business
we have that is purely speculative."
Within weeks after the announcement of the trading disaster, Lay
began damage control. He called an all-company meeting where the
Valhalla matter was discussed. At that meeting, Lay told the crowd that
he had known nothing about Borget's trading problems and that the
incident had blindsided the whole company. According to Muckleroy,
Lay said, "If anyone here believes I knew about this, then they should
stand up now."
In other words, Ken Lay was covering his ass and he was lying
about it. Lay had known about the problems in Valhalla. Woytek had
warned him. Muckleroy had warned him. Arthur Andersen had
warned him. And yet he had heeded none of them because he wanted
the profits that Borget had promised. As for Borget, he later pled guilty
to several criminal charges, was sentenced to a year and a day in
prison, and was ordered to pay about $6 million in restitution. Mastroeni was sentenced to two years' probation.
In the months after the Valhalla embarrassment, assets versus trading became the hot topic of discussion within the company's leadership.
Rich Kinder, Enron's chief of staff and a rising star in the company,
along with several other executives, became convinced that the trading
fiasco was a warning and that Enron had to remain tightly focused on
43
assets and the revenues that the company generated. The problem was
that Lay "never understood that the pipelines that are paid for and
power and processing plants that are mostly paid for, were the way to
make money," Muckleroy stated. "Lay forgot what happened at Valhalla." Another executive from that time period said that Kinder and
several others became "adamant that no more than 30 percent of our
profits could come from trading. The rest had to come from assets."
Given the magnitude of the near-disaster with Borget, that conservative approach appeared to make the most sense. However, the lead executives couldn't convince one key decisionmaker that their position was
the right one. "Ken [Lay] didn't have an opinion either way," he said.
Wow. Lay's lack of opinion on trading as a business in the wake of
the Valhalla fiasco is astounding.
He'd nearly lost Enron to a group of traders who were more interested in lining their own pockets than in making money for shareholders; they'd done it right under his nose by convincing Enron people in
Houston that they were making money, when they were actually losing
money. Lay had been warned months before the disaster not to trust
the traders, and he'd been warned to question their financial reporting.
The traders had hidden their losses by keeping two sets of books; and
finally, after the scam was discovered, Ken Lay stood up to proclaim his
innocence and insist that he didn't have any idea that such devious rapscallions could be in his midst.
It was a scenario that would be replayed in almost identical
fashionbut with far more devastating consequencesfourteen years
later. But first, Lay would have to become enamored with a brilliant
trader whose ruthlessness and deceptiveness would make Louis Borget
look like a rank amateur.
45
German submarines and the risk they posed to oil tankers traveling
along the coast. So they ordered the construction of the Big Inch and
Little Big Inch pipelines from Texas to the East Coast. The Big Inch
(twenty-four inches in diameter) transported crude oil. The Little Big
Inch (twenty inches) carried refined products. The two lines were constructed in record time and played a pivotal role in the Allied war
effort, which depended on oil to fuel its ships, planes, trucks, and
tanks. Oil was perhaps the most critical commodity during World War
II. The Allies had reliable supplies from Texas, Oklahoma, and elsewhere. The German and Japanese supply routes were longer and therefore more vulnerable to attack. As German general Edwin Rommel
wrote after his Afrika Corps was defeated at El Alamein, "Shortage of
petrol! It's enough to make one weep."1 American forces were seldom
short of petrol, and that was due in part to the Inch pipelines, which
together carried over 350 million barrels of crude oil and refined products to the East before the war ended. The pipes were later sold to
Texas Eastern. Today, they are owned by Duke Energy, and instead of
carrying oil, they carry natural gas.
Pipelines are the conduit for the American Dream. Every year,
pipelines carry some 550 billion gallons of crude and petroleum products to refineries, airports, rail yards, and other locations. Trillions of
cubic feet of natural gas are moved through some 2. million miles of
interstate, intrastate, and local pipelines.2 Pipelines are the largely invisible, sometimes dangerous, infrastructure that allows America to consume more energy than any country on earth. Pipelines, like airports,
highways, and railroads, have become an essential part of our transportation infrastructure.
By the early 1990s when Jeff Skilling, a former McKinsey consultant, began his rise to power within Enron, the company and its leaders
were, says one veteran gas man, "the kings of the American pipeline
business." Enron owned the greatest collection of tubular steel infrastructure ever assembled in one company. The company was transporting or selling 17.5 percent of all the gas consumed in the United States.3
Those pipelines were profitable, but they were, and still are, heavily
46
PIPE DREAMS
By 1991, Enron's meetings with Wall Street analysts had become fairly
routine: meet with analysts and investors, present Enron's message, discuss a few ongoing projects, then go play golf or tennis or hike in the
47
mountains. Enron had been holding the meetings for years, usually in
different locations in Arizona or Colorado. The setting made it all a bit
easier. Beaver Creek, which at that time, was still a fairly new resort in
the Colorado Rockies, was the location. The conference was to be the
forum for Jeff Skilling's first presentation to the analysts as an Enron
employeeand he was understandably nervous.
Skilling had only been on the job at Enron for a year or so. He'd
had some good success at McKinsey and in his early days at the
pipeline company, but he still had to prove to the analysts that he knew
his stuff. His job at the conference was to explain how Enron was
going to go beyond the pipeline business. He was to lay out the concepts behind Enron's model for commoditizing the natural gas business.
Once it was commoditized, Skilling believed that companies like Enron
would become traders. Skilling was going to show the analysts why
other companies were going to embrace Enron's ideas and how the
newly deregulated natural gas market provided Enron with a great
opportunity to grow its new business and get into new, sexier areas,
areas that had nothing to do with pipelines.
Skilling rose to the occasion. In his distinct baritone voice, he told
the analysts that Enron was going to provide hedging tools to major
gas consumers that would allow them to manage volatile prices. He
showed them how Enron would make money by providing those tools.
But the analysts were unimpressed. Several of them who attended the
meeting don't even recall Skilling's speech. A decade later, Skilling still
had vivid memories of the event. "The crowd yawned. They didn't get
it," recalled Skilling in spring 2001. "I was brilliant."5
Those three words contain the essence of Jeff Skilling's ego at its
acme. They also explain why he was so toxic.
Many things can be said about Skilling, but during his entire stint at
Enron, he never doubted that he was the smartest person in every room
he ever entered. And there was plenty of reason for him to believe that
was so. One former Enroner recalled, "You could give him a 2,oo-page
Power Point presentation, give him ten minutes, and he could ask the
48
PIPE DREAMS
three critical questions about the project. The uptake speed was phenomenal." Another Enron executive who worked closely with Skilling
for five years called him "the smartest son of a bitch I've ever met."
49
other colleges," said Betty Skilling, who added that the appearance of
the students ended up being a big factor in her son's decision to go to
SMU, where he accepted an engineering scholarship. At SMU, he joined
the Beta Theta Pi fraternitywhich was, coincidentally, the same fraternity that Ken Lay had joined at the University of Missouri about a
decade earlier.
At SMU, Skilling studied business and earned a B.S. in applied science. He graduated in May 1975 and a few days later married Susan
Long, a woman from the Chicago area he'd met at SMU. The newly
married couple got an apartment in Dallas, where Skilling got a job at
First City National Bank, in asset and liability management. But he was
unhappy at the bank, according to his mother. So he applied to Harvard Business School. "He said, 'I'll never make it in but I'm going to
try,'" Betty Skilling remembered. "And do you know what? He cried
when he got accepted."
At Harvard, Skilling found his element. He was no longer the
brightest guy in the class. Instead, he was immersed in a world of smart
people. And despite the stiffest academic environment he'd ever faced,
Skilling excelled at everything. In 1979, when he left Harvard with his
MBA, Skilling was named a George F. Baker Scholar, a designation
reserved for the top 5 percent of the students in his class, which contained about 800 students. Being named a Baker Scholar at Harvard
opens doors. And the key door that opened for Skilling was the one to
McKinsey & Company, the prestigious consulting firm.
Founded in 1925, the firm was started by James O. McKinsey, a
University of Chicago accounting professor and prolific author of texts
on management and accounting. His books led to a lucrative stream of
consulting gigs. And for the next two decades, McKinsey hired industrial managers in their forties to work as consultants. That approach
changed in the 19508, when the firm began recruiting newly minted
MBAs at America's best business schools. By the mid-1980s, McKinsey
was so heavily entrenched on campus that it was offering summer jobs
to 10 percent of the first-year students at Harvard Business School.7
50
PIPE DREAMS
51
By the late 19805, Enronalong with every other major pipeline company in Americawas suffering from the effects of a decades-long regulatory hangover.
A combination of low gas prices and an almost-but-not-quite deregulation of the industry by the Federal Energy Regulatory Commission
had forced the pipeline companies into near financial ruin. From the
19305 to the 19805, pipelines had been heavily regulated by the federal
government, which had taken the position that natural gas was a scarce
commodity and should therefore be conserved. The regulations were so
effective that during several cold winters in the 19708, a number of
cities across the country ran short of gas and had to cut off schools and
businesses. The regulations hadn't slowed gas consumption. They had
only succeeded in keeping gas prices artificially low, thereby stifling the
desire of prospectors to go out and drill for new gas supplies.
Perhaps the easiest way to understand the myriad of federal gas regulations that used to govern pipelines is to imagine a McDonald's franchise that instead of buying gas, purchases federally regulated buns for
resale. Under the old federal rules, the franchise was required to buy
all of its buns from one seller at a price determined by the federal government, and the buns would then be shipped to the franchise on a fed-
53
erally regulated toll road (pipeline), whose prices were set by the feds.
The regulatory scheme was cumbersome and complex, and it had to
be changed if America was to have an effective natural gas supply system. In 1984, under the deregulatory wave being pushed by Ronald
Reagan, the Federal Energy Regulatory Commission, the agency that
regulates America's pipelines, began repealing some of the restrictions
on pipelines. That year, the FERC allowed local gas distribution companies to buy gas from anyone, anywhere. That was fine, but it stuck
the gas pipelines with a multitude of "take-or-pay" gas contracts. During the 1970s, when gas shortages were common, many pipelines were
locked into long-term gas supply deals that obligated them to buy
(take) a certain amount of gas at a stated price that often had provisions that allowed producers to only increasebut not decreasethe
prices they were charging. If the pipelines didn't take all the gas they
had planned on, they had to pay for it anyway. And it didn't matter if
the price they were paying was far higher than the prevailing price of
gas. The 1984 ruling, known as FERC Order 380, hit the pipelines
hard because they were stuck with dozens of these suddenly very
expensive take-or-pay gas contracts. In 1985, the FERC, with Order
436, said that anybody who wanted to use interstate pipelines to transport gas could do so and that the pipeline companies had to provide
this service at a federally approved price, and that even though they
might be losing money, the pipeliners had to like it. It took two more
years for the FERC to create Order 500, which presented a financial
methodology through which the pipeline companies could negotiate
partial recovery of the costs of their take-or-pay contracts.1
Although this upheaval would ultimately prove beneficial to the gas
business as a whole, it caused tremendous pain for the pipeliners.
Columbia Gas Transmission, a pipeline outfit that served several Eastern states, struggled throughout the late 1980s with overpriced gas it
had purchased on take-or-pay deals. It went bankrupt in 1991. Other
big pipe owners such as Transco Energy and United Gas Pipe Line
spent years fighting with regulators and customers over gas pricing and
take-or-pay issues. Enron was able to resolve its take-or-pay problems
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PIPE DREAMS
fairly quickly in the late 1980s, but it still didn't have a viable business
plan that would allow it to break out of the pack.
Then, in 1989, Skilling, who was still working at McKinsey as an
Enron consultant, realized that there was plenty of gas availablefrom
producers who were being freed from federal price controlsand there
was plenty of demand, from new utilities that wanted to burn gas to
make electricity. But there was no intermediary that could aggregate
and more important, balancethe gas supplies coming from the producers with the demand coming from consumers. Why not create a
mechanism that would allow them to hook up? Skilling called his idea
the Gas Bank.
In Skilling's model, gas producers were "depositors" in the imaginary bank. Gas consumers were the "borrowers." The producers liked
the idea because Enron could give them long-term contracts for their
gas, and therefore, predictable cash flow, which allowed them to plan
their exploration and drilling budgets over a longer term. Gas users
liked it because they would be able to predict fuel costs over multiyear
terms. Enron benefited because it could latch onto a ready supply of
gas from its subsidiary, Enron Oil and Gas. Flatulent from its new
abundance of methane, Enron could guarantee delivery to gas consumers over long periods of timefifteen years or more.2 Enron would
make its profit on the contracts by pocketing the "spread" between the
cost of the gas and the selling price.
Despite the brilliance of the idea, Skilling wasn't sure it would work.
For weeks after he hatched the plan, he was racked with doubt, certain
he had ruined his career. However, that doubt was accompanied by a
parallel belief that he was smarter than anyone else. "I believed this
whole world would be different, a huge breakthrough," he told Texas
Monthly's Mimi Swartz in 2001.3
Skilling needn't have worried. The Gas Bank was a smash.
Shortly after the company launched the concept, Enron Gas Marketing sold some $800 million worth of gas in one week's time.4 The
volume of gas Enron was selling soared. Within months of the launch
55
of Gas Bank, the company was selling 1.1 billion cubic feet of gas per
day. To put that amount in perspective, the average American home
uses about 88,000 cubic feet of gas per year. By 1990, it was selling 1.5
billion cubic feet of gas per day.5 Within two years, Enron had signed
contracts with thirty-five producers and more than fifty gas customers.
The Gas Bank was "a turning point for Enron for several reasons,"
said one source who worked closely with Skilling. "First, it put Skilling
on the map. He was still at McKinsey. then. It was his concept. It made
a major mark." Skilling's strategy really impressed Ken Lay, as well as
Rich Kinder, who by 1989 had risen to the rank of vice chairman of
Enron. "Second, it demonstrated to the world and to utilities that this
was the first big innovation in the gas business and it was being done
by Enron, so it solidified Enron's position in the market."
Profits from the Gas Bank were almost immediate. Industrial customers and power generators were willing to pay a premium for a guaranteed gas supply. Within two years of launching the service, Enron
was selling fixed-price, ten-year gas contracts with average prices as
high as $3.50 per 1,000 cubic feet, even though gas prices were stuck at
about $1.30. That meant that on a handful of contracts, Enron was
able to make $2.2,0 per 1,000 cubic feet of gas, a handsome profit by
any measure.
In addition to making money, the Gas Bank had several additional,
very positive effects for Enron: It made gas-fired power plants much
more attractive to lenders. More gas-fired power plants meant more gas
consumption, and that meant more business for Enron's pipeline and
trading business. And finally, it helped create a futures market in natural gas, a market that Enron would soon dominate.
Today, natural gas-fired power plants are common. But in the late
19805 and early 19903, almost all of America's electric power came
from coal and nuclear sources. Natural gas was hampered by concerns
about supply (having enough gas) and price (making sure the gas
wasn't too expensive). But with the advent of the Gas Bank, a power
company that wanted to build a gas-fired plant could safely estimate its
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PIPE DREAMS
energy costs over a long period of time. That gave lenders the comfort
level they needed to provide financing. In December 1990, Enron
signed a huge gas deal that achieved that very purpose. The company
signed a twenty-three-year-long $1.3 billion contract with the New
York Power Authority that called on the company to deliver gas to the
authority at a fixed price for ten years. After that, the price would be
adjusted monthly based on market conditions. With the fixed-price gas
in hand, NYPA was able to go forward with a plan to build a 150megawatt power plant on Long Island.
The NYPA deal was the first major power plant contract for Enron.
It would lead to many more. And though the Gas Bank had quickly
proven its worth, Skilling saw another opportunity. Enron was having
trouble locking up gas supplies for the Gas Bank because many gas producers couldn't get the financing that they needed. Banks were, for the
most part, in terrible shape. The excesses of the 1980s, including
wagon loads of bad real estate and oil deals, had decimated banks and
savings and loans in the Oil Patch. Lending officers were skittish about
everything having to do with energy. Enron needed to lock up more gas
production. To do that, Skilling realized the company had to go
upstream. That is, Enron had to start locking up gas while it was still in
the ground, and to do that, the company would have to start lending
money to producers. In short, it would have to step into the role formerly taken by banks: Enron would provide financing to oil and gas
producers so they could develop their properties. In return, the producer would promise to sell the hydrocarbons from that oil field to
Enron at an agreed-upon price. Enron would then sell the gas through
the Gas Bank. The prospectors would get the up-front cash they needed
to develop gas fields that otherwise might not be producing at all.
Skilling took the idea to Ken Lay and Rich Kinder, with one proviso: Hire him to run the business. The two quickly agreed. And on
August i, 1990, Skilling walked into the building at 1400 Smith Street
as chairman and chief executive officer of the newly created company,
Enron Finance Corp.
57
Jim Floras and Billy Rucks had a good idea, they just didn't have
enough money. The two landmen had been poring over records on offshore leases and they believed a field that Shell Oil was selling had
good prospects. The field was located a few miles offshore from what
would be the lips of the mouth of the Mississippi River. Shell assumed
the lease was just about depleted and was ready to unload it.
By late 1990 and early 1991, Flores and Rucksone former Enron
official refers to the two as "a couple of broke-assed Louisiana landmen"were certain that Shell was making a mistake. The two men
believed that Shell's field, called Main Pass 69, was likely to contain up
to 80 million barrels of oil. Not an "elephant" (the oil industry's term
for gigantic fields), but it was certainly worth developing. So the two
went to Enron. According to Rucks, "There were no other financing
sources at that time. The banks were getting hammered." He also
added that he and his partner "weren't broke-assed, but we weren't
rolling in dough."
After showing their seismic data to the geology and finance hotshots
that Skilling had hired to work at Enron Finance, Flores & Rucks (the
eponymous company owned by the two men) had a deal. In early 1992,
Enron Finance lent the young company $46 million. A year later, the
two parties agreed on another deal, $ 160 million in financing for a field
right near the mouth of the Mississippi called East Bay. With those
deals, Flores & Rucks was suddenly on the map, and the old oil fields
they'd bought were more prolific than they had ever dreamed. "We
were able to increase production in that field to over double of what we
bought it for," Rucks remarked. "We did that within two years."6
Rucks was quick to give Enron credit for much of hisand his company'ssuccess. "Enron Finance was of paramount importance to Flores & Rucks's becoming a significant E&P [exploration and
production] company," said Rucks. "Those financings, initially, were
very important." He remembered Enron being full of "bright people
who were superexcited about their deal. They wanted to make a great
company and they were really focused on it." And he said that Enron
forced Flores & Rucks to adopt the discipline it needed to go public,
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PIPE DREAMS
which it did, in 1994. Rucks also credited Skilling. "He had tremendous juice within the company. When we were doing business with
them, Jeff was the creator of the concept and the drive behind all of
them. He had the power. And at that point, rightly so. He was making
it happen over there. He was taking them into areas that were so far
out there, that no one had even thought of them."
Prior to the deals Enron Finance did with Flores & Rucks, Skilling
had done several other major deals. One deal had provided profits of
$11 million. In another deal, Enron provided $38.5 million of the $45
million that Denver-based Forest Oil Corporation needed to purchase
some promising properties. Enron got about half of the 48 billion cubic
feet of gas Forest was going to produce and was able to sell it for a
profit of six to eight cents per 1,000 cubic feet. Spreads of that kind
gave Enron profit margins that were higher than any of its competitors.
Although the money Enron made on Forest was good, the profits
from the Flores & Rucks deal were the fall-down-laughing kind of
money. Rucks estimates Enron profits at $20 to $30 million. Some people within Enron believe the company's profits on the Flores & Rucks
deal were closer to $100 million. Whatever the real number, Skilling
had learned he could do monster dealsand he loved it.
The Flores & Rucks deal was a perfect complement to Enron's trading business, which, thanks to the Gas Bank, was growing faster than
anyone had expected. Although crude oil futuresas well as futures in
refined products like gasoline and diesel fuelhad been traded on various exchanges for decades,7 natural gas futures were not traded for a
simple reason: There was no market for them. Federal regulation of the
gas business had prevented the creation of a functional gas futures market. The Gas Bank helped change that. There was another major factor
that allowed Skilling's trading vision to happen: In 1990, the New York
Mercantile Exchange (NYMEX) began trading futures based on delivery of gas to the Henry Hub, a major gas depot in Louisiana where
fourteen different intra- and interstate gas pipelines come together.8
That gave gas traders the catalyst they needed. With the NYMEX's
published prices, traders were given a reliable market index that they
59
could then use to establish prices for all kinds of gas contracts. And
Enron was leading the charge in almost every part of the business.
As Skilling watched the uptick in tradingthe area he believed
would be hugehe became convinced that Enron's accounting had to
change. He wanted Enron to switch to a bookkeeping method favored
by finance companies, not energy companies. That method is called
"mark to market."
Mark-to-Market Account-a-Rama
MARK-TO-MARKET ACCOUNT-A-RAMA
61
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PIPE DREAMS
it made as the money came in. For example, assume Enron was a
Venetian company that had signed a contract to sell another company
one boat each year for ten years, with each boat costing $100. Under
Pacioli's rules, Enron would have only been able to record the $100
debit (and credit) for the sale once each year.
But under mark-to-market accounting, Enron could estimate the
total value of the ten-year deal at any price it chose. So although total
revenue was projected at $1,000, Enron could slap a net present value
on the deal of, let's say $800, and enter that $800 debit in its ledger
right away. The deal gets completed by the entry of an $800 liability on
Enron's balance sheet.
The problem was, of course, that Enron didn't have $800 in cash. It
only had $100 cash from the sale of the first boat and a promise from
the buyer that he would buy another boat per year over the next nine
years. Further assume that Enron, being an aggressive trader in Venice,
saw that the price of boats was increasing and that in three years' time,
a boat that it was now selling for $100 might be selling for $150. That
meant that under the mark-to-market method, Enron could increase
the value of the ten-year contract to $1,050, or even more, and book
that revenue right away. The company would arrive at that value by
creating a price curve.
Projections of future pricing are mapped on a price curve. Optimistic
promoters always use price curves that look like a hockey stick. That is,
they assume future prices of the widgets they are selling will soar.
Estimating future prices of anything is difficult. But traders of commodities have to do it to protect themselves from price volatility. For
some commodities and time periods, creating price curves is a snap. For
instance, the New York Mercantile Exchange has readily available
prices for crude oil that will be delivered at the New York Harbor in
sixty days. Similar prices are available for commodities like orange
juice, coffee, pork bellies, and cotton. But price curves have a limited
utility, particularly when the time lines are extra-long. For instance,
who can say with any accuracy how much natural gas will cost in
twenty years? The Amazing Kreskin might be able to predict that, but
MARK-TO-MARKET ACCOUNT-A-RAMA
63
no one in the energy business can. For example, futurists and hopeful
oilmen have been predicting for years that crude oil would cost $50 per
barrel within two decades of whatever day they were making their prediction. Those dire predictions have, so far, been proven wrong,
because oil exploration and production companies continue to find
ever more oil and natural gas in ever-more-remote locales.
The ability to change price curves to suit the needs of a particular
deal can create a tempting option for an accountant. If a company needs
extra revenues, an (unscrupulous, or perhaps "creative") accountant
can simply "move the curve," that is, adjust the price curve on a particular deal. With a fatter curve, the company can magically generate additional revenue (non-cash revenue) without having to go to the trouble of
actually providing any goods or services to a customer. Enron's ability to
manipulate price curves on its long-term contracts would become very
important as its derivatives business grew ever larger.
Many accountants and traders believe that mark-to-market
accounting is the best way to reflect the true value of a business, particularly one that does complex or long-term financial deals with contracts or investments that fluctuate in value. Mutual funds are a good
example of mark-to-market accounting. Every trading day, every publicly traded mutual fund prices all of the securities it holds. And at the
end of the day, it publishes the net asset value of those securities. Mark
to market works particularly well for items that are fungible (stocks,
for instance), which is a fancy word for something that is easily bought
or sold on the open market. Big Macs and Bic pens are fungible.
Nuclear missiles are not.
Mark-to-market accounting is useful, too, when valuing items that
are common but not easily exchangeable, like office space. Suppose a
real-estate leasing company owns an office building that is leased to
five tenants, each of whom uses 2,000 square feet costing $i per square
foot per year. Lease costs are increasing. So the company renegotiates
one lease for $1.25 per foot. Under mark-to-market accounting, the
company recalculates the value of its other four leases, which, given the
new valuation from the new lease, are worth more, even though their
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rents cannot be increased until the old leases expire. The old leases are
only paying $8,000, but under mark-to-market accounting, their true
value is $10,000. Add in the value of the new lease, $2.,500, and the
real estate company now has revenue of $12,500, even though it is only
receiving cash of $10,500 ($2,500 from the new lease plus the $8,000
from the old leases).
Within a few months of his arrival at Enron, Jeff Skilling began pushing
the company to adopt mark-to-market accounting for his group, which
had changed its name to Enron Gas Services Group. Skilling argued
that he needed the new method so that his people could properly value
the long-term gas-supply contracts they were selling. But there were
other motives behind Skilling's push for mark to market. He knew that
by recognizing revenues more quickly, his group would be able to show
significantly faster growth than any other part of the company. That
meant he would get more recognition and move up the corporate ladder faster.
More important for Skilling, the adoption of mark-to-market
accounting would put millions of dollars in his own pocket, and it
would do it very quickly.
Buried in the 1990 Enron proxy statement (the form distributed to
shareholders that lists executive salaries as well as their stock options
and stock holdings) are the details of Skilling's employment contract
with the company. In addition to a salary of $275,000 and a loan of
$950,000, Skilling got Enron to pay him cash bonuses for any increase
in the value of the company he was creating. The proxy says Skilling
would get "a grant of phantom equity rights entitling him to receive in
cash specified percentages of the market value of Enron Finance Corp."
Under the deal, if Skilling's company grew to be worth $200 million,
Enron would pay Skilling $10 million. If it grew to a valuation of $400
million, Enron would pay him $17 million.
Enron's proxies show that the terms of Skilling's equity-appreciation
deal changed slightly in subsequent years. The 1997 proxy says that
Skilling was paid about $2.5 million in cash under the terms of the
MARK-TO-MARKET ACCOUNT-A-RAMA
65
equity deal for the year 1995. That same proxy says Skilling was
granted an additional $6 million worth of stock options in Enron Corp.
Those payments were in addition to the regular salary and bonuses
Skilling received from the company.
The Enron proxies from 1990 through 1996 are silent concerning
how much Skilling was paid in those years under the terms of the original contract. Whatever the total, it's clear that Skilling was able to personally enrich himself by many millions of dollarsperhaps tens of
millionsbecause he convinced Enron to adopt the more aggressive
accounting method. His arguments, according to sources close to the
matter, revolved around the need to have an accounting method that
worked well for trading. The big Wall Street firms used mark-to-market
accounting for their trading businesses. If Enron was going to be a
player in the gas trading business, it couldn't be stuck with accrual
accounting. It simply had to change its methods.
"Mark-to-market accounting was Skilling's brainchild," said one
executive familiar with the accounting change. "He convinced Ken Lay
on it. Then he convinced the Audit Committee and the board."
Skilling began seeing the potential for the new accounting method in
late 1990, about the same time that a group of Enron salespeople, led
by John Esslinger and Ken Rice, closed one of the biggest long-term
gas-supply deals in the history of the energy business. The contract with
the New York Power Authority called on Enron to deliver 3 3 million
cubic feet of natural gas per day to power plants built or operated by
the authority. The twenty-three-year-long deal gave the authority fixedprice gas for ten years and adjustable prices based on index prices for
the remaining thirteen years. The total value of the contract was $1.3
billion. But under accrual accounting rules, Skilling could only take
1/23 of the revenues from that contract every year. If his group could
use mark-to-market accounting, he could pull most of that future revenue into the current quarter to make his business unitand himself
look better.
Enron was particularly aggressive in selling long-term gas contracts
like the one with NYPA that extended out ten, fifteen, or even twenty
years. At that time, no other energy company was willing to make long-
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term bets like those because there were no reliable pricing schemes that
allowed them to quantify their risks. But Skilling saw that as an advantage. If gas was selling for $2 per thousand cubic feet in 1990, Enron
could simply assume (read: make a wild-ass guess) that it would cost $8
in 2010. And through the magic of malleable price curves and mark-tomarket accounting, Enron could then assume a juicy hunk of revenue
from that contract right away, and enter it on its books.
In short, nobody had ever done the type of transactions that Enron
was doing, so no one could evaluate whether the contract was good or
bad. The elasticity of the price-curve mechanism allowed Skilling a way
to continually adjust the amount of revenues his business was making.
It was a methodology that Skilling and his mafia would use repeatedly
in the coming years, with disastrous consequences.
The hugeand immediaterevenues he could get from the NYPA
deal convinced Skilling that mark to market was the way to go, said
another executive who worked closely with Skilling. The former McKinsey man saw the method as "a way to enhance his own pocketbook. He
was looking at the value that the New York Power Authority contract
would bring to the table. He was never thinking of anything other than
how to enhance his paycheck."
But by getting mark to market, Skilling not only enhanced his own
paycheck, he started a series of events that took Enron's focus away
from cash and cash flow and put it on revenue growth. And therein lies
one of the seeds of Enron's destruction: Almost exactly one decade
before Enron went bankrupt, the companyand Skilling in
particularbegan focusing attention not on generating something as
old-fashioned as cash but rather on doing deals that allowed the company to foster accounting legerdemain with mark-to-market income.
Revenue growth became more important than cash. It was a mindset that would put Enron in a cash crisis.
MARK-TO-MARKET ACCOUNT-A-RAMA
67
minutes of the meeting say the committee debated "a new accounting
concept to be utilized by Enron Gas Services Group"the new name
for Skilling's group. The new method "will provide a better measure of
Enron Gas Services' results in managing its portfolio of contracts than
would be reflected by historical cost accounting concepts, and, therefore, is in the best interests of the Company." The motion to approve
the concept was made by Robert Jaedicke.
As soon as the method was approved by the Audit Committee,
Enron and its auditor, Arthur Andersen, began lobbying the Securities
and Exchange Commission for permission to use mark to market. They
got that permission in a letter dated January 30, 1992. Walter P.
Schuetze, the SEC's chief accountant, said mark to market could be
used only within Enron Gas Services for use on its natural gas trading
business. The letter also said the SEC "will not object to the proposed
change in the method of accounting by Enron Gas Services during the
first quarter of its fiscal year ended December 31, 1992.."
Thus, with the SEC approval, Enron became the first non-financial
company to be given approval to use mark-to-market accounting.
Although Enron had the approval it desired, it wasn't quite enough. On
February 11, 1992, Enron's chief financial officer, Jack Tompkins,
wrote Schuetze back, saying that the company was going to ignore the
SEC's approval date and institute mark to market a full year earlier
than the SEC expected. "Enron has changed its method of accounting
for its energy-related price risk management activities effective January
1, 1991," said Tompkins. "The cumulative effect of initial adoption of
mark-to-market accounting, as well as the impact upon 1991 earnings
is not material."
In other words, Enron would use mark-to-market accounting as it
saw fit, not as the SEC had instructed. And according to auditors who
worked at Enron, the company was also lying about the materiality of
the use of mark to market. "Without the use of mark to market, Enron
would have had a down quarter during the last quarter of 1991 and the
market would have killed them for it," said one auditor who worked
closely on the matter. "It was material to Enron's earnings. And from
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that point on, Enron started using mark to market in every part of the
business, not just Enron Gas Services."
For reasons that aren't clear, the SEC apparently never objected to
Enron's retroactive use of mark-to-market accounting in 1991. And the
agency's approval of the accounting method gave Skilling all the
momentum he needed. On the day the letter arrived from Schuetze,
Skilling began celebrating. "He came down to the trading floor with a
bottle of champagne that day," said one executive who had worked for
Skilling. "He was one happy camper."
And though mark to market helped fuel Skilling's ambition and his
drive to remake Enron into a trading company, he had to compete for
Ken Lay's attention. Another group at Enron, led by a hyperaggressive
Vietnam veteran, was building power plants in Texas and in England that
were making money. Lots of money. And that got Ken Lay's attention.
1992
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71
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The Texas City deal was just one of many deals Enron made with
Drexel. The Wall Street firm had provided Lay with $615 million to
help close the HNG/InterNorth merger. Between 1985 and early 1988,
Drexel was to provide Enron with more than $2.94 billion in bonds
that were spread among eight different transactions.2
Finished in 1987, the Texas City power plant began selling electricity to a local utility. It also sold electricity and steam to a nearby Union
Carbide plant. With a pittance invested, Enron's profits from the Texas
City project were enormous. The company was profiting twice on the
same project: from selling the gas to the plant and from selling the electricity the plant generated. From the beginning, according to one Enron
finance person, the Texas City facility was making "a ton of money."
The success at Texas City convinced Wing that bigger opportunities lay
overseas. And in 1989, after convincing Ken Lay and the Enron board
of the merits of the project, he left for England. The decision would
have profound long-term consequences.
Wing saw a British market ready for competition. Prime Minister Margaret Thatcher, the conservative leader, was pushing deregulation
throughout the British economy. She had pushed for the sale of British
Gas, and the country was planning to open its electricity markets to
competition.
Wing and another Enron official, Bob Kelly, spent most of 1989 and
1990 promoting their plan for a huge cogeneration plant at Teesside, in
northeastern England. Like the Texas City plant, the new project would
generate power and steam. The steam and a small portion of the power
would be sold to a neighboring facility, a nylon and chemical plant
owned by ICI Chemicals & Polymers Ltd. Most of the electricity would
be sold to four local electric utilities, all of which were expecting to be
privatized. By November 1990, Wing had a deal. Enron's project was
approved by John Wakeham, Britain's secretary of state for energy, who
later became an Enron board member. And the 1,725-megawatt
Teesside project became the first independent plant approved in the
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75
utive. "It was done because of Ken Lay's infatuation with the international business."
Some people at Enron believe Wing's big paycheck was justified. He
had done Texas City and he'd done Teesside, both with minimal exposure to Enron, and both very profitable. Wing may have been worth it.
Enron needed him more than he needed Enron, so the company had to
pay up. Worth it or not, Wing's paycheck at Teesside became the standard by which future international projects were measured. And every
one of Enron's international power plant developers began expecting
lucrative bonuses for their deals. "Wing started the excessive-compensation ball rolling," said an executive who worked closely with Lay and
Wing. And with so much money at stake, Enron's international team
began pushing projects that Wing would likely have never considered.
Teesside also convinced Enron that the international market was
ripe for picking. According to one senior Enron executive, the project
"made Enron's international reputation. It was a watershed event. It
made Enron's name in the international power business. The only
problem was it allowed us to get into other bad deals." Indeed, long
before the Teesside plant was completed, Enron's money-hungry
hordesled by Wing's protege and former lover, an executive named
Rebecca Markbegan pushing for big power plants everywhere. The
most ambitious one was located at a remote port in India that was one
of the legendary stopping points for Sinbad the Sailor, a place called
Dabhol.
Finally, Teesside convinced Ken Lay that if Enron was going to be a
player in the international energy business in places like the United
Kingdom and India, it needed to have friends lots of friendsin
Washington.
FEBRUARY 1993
77
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government for $143 million. Two decades later, the pipeline was
worth ten times that amount. In his book The Politician: The Life and
Times of Lyndon Johnson, author Ronnie Dugger wrote that in 1954, a
public relations man for Brown & Root boasted that the firm had done
"a billion dollars worth of work for the Army and Navy." And many of
those contracts were steered, either directly or indirectly, to Brown &
Root by Johnson, who, in return for the federal deals, built a pipeline
of his ownone that carried a river of campaign cash from the
Browns' bank accounts into his own accounts. In 1957, Johnson wrote
to his friend, saying, "I invariably find that my chief asset is that I have
George Brown as a friend."
In 1960, while Johnson was on the presidential campaign trail with
John F. Kennedy, a joke made the rounds. It starts with Kennedy, a
Catholic, telling Johnson, "You know, Lyndon, when we get elected,
I'm going to dig a tunnel to the Vatican." To which Johnson replies,
"That's okay with me as long as Brown & Root gets the contract."6
During Johnson's tenure in the White House, the relationship continued and Brown & Root was awarded huge construction projects
during the war in Vietnam. The firm built ports, roads, airports, and
anything else the Pentagon asked for. In his biography of Johnson, Dugger summed up the relationship: "If Lyndon was Brown & Root's kept
politician, Brown & Root was Lyndon's kept corporation."7
Brown's political patronage didn't stop with Johnson. He was also a
regular in Suite 8-F, the room at the Lamar Hotel where Houston's
power elite of the 19505, 1960s, and 1970s gathered on a regular basis
to eat lunch, drink whiskey, play poker, and decide which politicians
would get their money and their backing. The "8-F crowd" included
the city's richest businessmen, people like insurance magnate Gus
Wortham, Houston Chronicle publisher Jesse Jones (who owned the
Lamar and lived on the top floor), Judge James Elkins, the founder of
the law firm Vinson & Elkins, and Oveta Culp Hobby, the publisher of
the Houston Post. George Brown was the undisputed leader of Suite 8F, the group that was, in effect, Houston's real government.
By the 1970s, another Houston powerhouse was cultivating friends
in high places. Lay's predecessor at Houston Natural Gas, Bob Herring,
79
was a jet-setter and political animal who lunched with former secretary
of state Henry Kissinger in Washington and flew to Riyadh for chats
with Crown Prince Khaled. When Lay took over at Enron, he not only
bought Herring's old house, he also began emulating his style. Like
Herring, he became active in local charities and politics, and began supporting Rice University and serving on local boards. And by 1993, with
Enron's international business on the rise, Lay needed some friends
with big Rolodexes and even bigger resumes.
Ken Lay was going to succeed Herring and Brown with his own version of Suite 8-F. He was going to be Mr. Houston. To do that, he
needed to develop a group of powerful friends. So he hired James A.
Baker III.
In a February 22, 1993, press release announcing the hiring of
Bakerthe grandson of the old Harris County judge as well as a former
secretary of state and top official serving under three different Republican presidents and Robert Mosbacher, the former secretary of commerce, Lay gushed that Enron was "delighted to have these two
individuals, who have such a wealth of international experience, join us
in the development of natural gas projects around the world." And who
wouldn't have wanted Baker, the man who used to sign our greenbacks
and knew oodles of prime ministers by their first names? Baker, the former secretary of the treasury, as well as chief of staff under Ronald Reagan, was simply passing through the paved-with-gold revolving door
between high-level government service and the aristocracy of the lobbyist-fixer. His money grab with Enronwhich began almost exactly one
month after his boss, George H. W. Bush, moved out of the White
Housewas the most blatant abuse of the revolving door since Henry
Kissinger began pimping his basso profundo and his Rolodex to any
company with a big checkbook. (Enron was one of Kissinger's many
clients. The company kept him on the payroll for several years in the
hope that he'd help open doors in China and elsewhere.)
Baker and Mosbacher had other attributes that made them valuable to Enron. Both were Houstonians. Both were longtime energy
guys. And both had strong ties in countries where Enron was pushing
power projects, including the still-smoldering ruins of Kuwait, which
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was just beginning to recover from the damage done by Iraqi troops.
As recounted in a September 6, 1993, article by Seymour Hersh in
the New Yorker,8 within six weeks of being hired by Enron, Baker was
flying to Kuwait on a Kuwait Airways plane alongside his old boss, former president of the United States, George H. W. Bush. The former
president was going to Kuwait in April 1993 to get medal from the
Kuwaitis. Baker was there to lobby them.
The former secretary of state, who just a few months earlier had discussed strategy with the Kuwaitis, was now trying to sell the country's
just-back-from-exile royal rulers on the merits of a 4oo-megawatt
power plant that Enron wanted to rebuild at Shuaiba, an industrial
zone south of Kuwait City. Also on the plane was former U.S. army
lieutenant general Thomas Kelly, who'd joined the Enron board in
1991, shortly after the war against Iraq ended. Kelly had become a
CNN regular during the war, thanks to his almost daily appearances
before the press corps. By the time of the 1993 trip, according to
Enron's proxy statement, Kelly was no longer on the Enron board.
However, he was still working as a consultant to Enron, and his compensation was based largely on his ability to get contracts on new
power plants. (In addition to Enron, Kelly had another client at the
time, the Wing-Merrill Group, an independent power company started
by John Wing, who'd parted ways with Enron after Teesside.)9
Baker's lobbying for Enron didn't stop in Kuwait. He pushed Enron
projects in Turkey, Qatar, and Turkmenistan as well.10 He also wrote a
political risk paper for Enron on the dangers of investing in the Dabhol
project in India. Enron never bothered to reveal the amount of money it
was paying Baker or Mosbacher. But one published report said that
Kelly, who arguably had the least power of the three men, was going to
be paid between $400,000 and $1.4 million.11
In his report on Enron's new hired-gun lobbyists, Hersh quoted a
disgusted former army general, Norman Schwarzkopf, who had commanded American troops during the war. "In the Arab world, your
position in government may get you through the door, but it's the personal relationship that gets you the contract.... American men and
81
women were willing to die in Kuwait. Why should I profit from their
sacrifice?"
Baker and Lay had no such qualms.
"I reject the suggestion there's something inappropriate in this,"
Baker told ABC shortly after the Hersh story appeared.12
Lay was similarly cavalier. "Is there any reason American companies
shouldn't profit from the war in Kuwait?" he asked. "What's wrong
with hiring former American officials to encourage investments anywhere in the world? Jim Baker has given us some very helpful advice to
be more competitive in the world. I ask you, what in the hell is wrong
with that?"
There's nothing illegal about hiring former government officials. In
fact, Lay began making a habit of it. While the Baker-Mosbacher-Kelly
triumvirate was helping overseas, Enron scored a major coup by hiring
Wendy Lee Gramm just five weeks after her tenure on the Commodity
Futures Trading Commission ended. And if ever there was a case of
political payback, Enron's hiring of Wendy Gramm is it.
When Lay announced the hiring of Gramm, a Ph.D. economist, he
said her "experience in financial and commodities markets will prove
extremely valuable to Enron." What Lay didn't say was that Wendy
Gramm had just given Enron a major regulatory bonus. During her very
last days as lame-duck chairman of the CFTC (which was short two of
its five members), she won hurried passage of a federal rule that
exempted energy derivatives contractsan area that was rapidly becoming one of Enron's most profitable businessesfrom federal regulation.
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which would cost him $5,000, he goes to a brokerage house like Merrill Lynch or Charles Schwab and buys an option for, let's say, $100,
which gives him the rightbut not the obligationto buy 100 shares
of Acme Corporation stock at $50 a year from today. In broker parlance, it's a "call option." A call is an option to buy at a fixed price.
If, in a year, Wilbur is proven right and Acme Corporation stock
rises to $60 (or higher) his option is valuable. He exercises his option
with Schwab, which then sells him 100 shares of Acme Corporation for
$50 per share. Wilbur immediately sells that same stock for $60 per
share. He then pockets a tidy profit of $900 ($1,000 profit on the
stock, minus the $100 cost of his option).
The option allowed Wilbur to use his money more effectively.
Instead of investing $5,000 in Acme Corporation stock, he invested
$100 in an option and was still able to benefit from the stock's price
increase. However, Wilbur might have bet incorrectly. Let's assume that
Acme Corporation stock fell to $40 at the end of the option period. In
that case, Wilbur simply lets the option expire and does nothing. His
only loss is the $100 cost of the option.
"Put options" work the other way. A put is an option to sell at a
fixed price.
Wilbur Smith thinks Acme Corporation is overpriced. He goes back
to Charles Schwab and buys a put option (again, assume the option costs
$100) that gives him the rightbut not the obligationto sell Acme
Corporation stock to Schwab in one year, for $50. A year later, if Acme
Corporation stock falls to $40 (or lower) Wilbur can exercise his option.
Schwab buys the stock from Wilbur for $50 a share. Wilbur again pockets $900 ($1,000 from the sale, minus the $100 cost of the option).
Enron's derivatives business followed a very similar pattern. But
instead of selling to individuals like Wilbur Smith, Enron sold them to
big industrial customers and energy companies. And rather than purchase stock options, the big companies (small companies, too) were
buying and selling put and call options on commodities like natural gas
and electricity or interest rates.
For instance, suppose ABC Utility Company owned a gas-fired
83
power plant and wanted some assurance that its fuel costs for the plant
would not exceed a certain limit. ABC could buy a call option from
Enron that allowed it to buy 1 million cubic feet of gas per day for a
period of one year. The price on the gas could be set at a fixed price or
a floating price that fluctuates based on spot market prices set by the
New York Mercantile Exchange for certain locations, like the Katy
Hub, a terminal twenty miles west of Houston. With the option in
hand, the utility could then make more accurate forecasts about its revenues and cash flow. In other words, by purchasing the option, the utility was hedging its price risk. ABC was spending a little money for an
option from Enron that protected it in case natural gas prices soared.
That type of contract is a derivative. Simply stated, a derivative is a
financial contract between two (or more) parties that is based on an
underlying commodity.
In addition to options, Enron sold and boughta dizzying array
of other derivatives worth tens of billions of dollars. These deals
included forward contracts, futures, energy swaps, and one of the most
common derivatives, interest rate swaps. Enron could buy and sell these
complex contracts alongside big financial institutions like Citibank or
J.P. Morgan Chase or Morgan Stanley. But unlike the Wall Street firms,
Enron didn't have to get a securities license or register with the Securities and Exchange Commission. It didn't have to comply with the rules
of the New York Stock Exchange or report to anyone how much real
cash it was using to back all of its derivatives.
Wendy Gramm's exemption allowed Enron to, in essence, run its
own derivatives exchange. But unlike exchanges, such as the New York
Mercantile Exchange and the Chicago Board of Trade, both of which
have collateral requirements that are overseen by the Commodity
Futures Trading Commission, Enron could set its own standards, a fact
that would allow it to become one of the key players in the burgeoning
multitrillion-dollar over-the-counter derivatives market.
Enron's purchase of Mrs. Gramm started on November 16, I99Z,
just a few days after Americans voted to oust President George H. W.
Bush and replace him with Bill Clinton. That day, Enron and several
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"Kenny Boy"
No member of the Bush family has ever been on the
Enron payroll.1
KEN LAY, JUNE 2000
Surely it's just a coincidence. What else would explain why Enron Oil
and Gas, a subsidiary of Enron Corp., would have been in business
with George W. Bush way back in 1986?
Bush the Younger was many things, including the eldest son of the
vice president of the United States. A successful oilman he was not.
Bush's forays into the energy business had been nothing short of disastrous. In 1984, Bush had no choice but to merge his faltering firm,
Bush Exploration Company (which had previously been called
ArbustoSpanish for shrub) with another firm, Spectrum 7, which had
the main virtue of being somewhat profitable. But by mid-1986, Bush
had done his magic on the privately owned Spectrum 7. The company
wasn't producing much energy of any kind, and Bush was actively trying to sell yet again, this time to an exploration and production company called Harken Energy. Despite Spectrum 7'5 lousy record, it
somehow got into business with Enron Oil and Gas. And on October
16, 1986, Enron Oil and Gas announced that it had completed a well a
few miles outside of Midland, Texas, that was producing 24,000 cubic
feet of natural gas and 411 barrels of oil per day. Enron owned 52 percent of the well. Ten percent belonged to Spectrum j.2
Now, the oil and gas business is full of speculators, and wells are
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often drilled with multiple investors with varying backgrounds. But the
early Bush-Enron connection, which was first reported by David Corn
of the Nation, points out just how small the energy business is. Two
years later, the energy businessat least as far as George W. Bush and
Enron are concernedwas made even smaller. That's when Rodolfo
Terragno, Argentina's minister of public works, got a call fromwho
else? George W. Bush.3
Terragno was overseeing the bidding for a major gas pipeline that
would connect Argentina's natural gas fields with foreign and domestic
customers. He was considering two proposals for the pipeline, which
was expected to cost $300 million. One proposal was from an Italian
firm, the other was from an Argentine company that was working with
Dow Chemical. Then, after nearly a year of deliberation, Enron jumped
into the bidding. "I had a lot of reservations about Enron because the
company wasn't well established in Argentina," Terragno told Lou
Dubose, who broke the story in Mother Jones magazine.4 Terragno said
he was lobbied by the U.S. ambassador to Argentina, a fact that didn't
surprise him. What did surprise him was the call from George W. Bush,
who phoned him a few weeks after Bush's father won the November
1988 election. "He told me he had recently returned from a campaign
tour with his father," Terragno told Dubose. And Bush made it clear
that he wanted Terragno to give Enron the pipeline deal. Bush told him
that the Enron deal "would be very favorable for Argentina and its
relations with the United States."5
Terragno never got to act on George W.'s recommendation. In 1989,
his boss, Argentina's president, Raul Alfonsin, was voted out of office.
In his place came right-wing politico Carlos Menem. And within three
years of Menem's election, Enron was able to buy a major stake in
Argentina's pipeline system. Perhaps the Spectrum 7 and Argentina
deals are coincidental George W. Bush's handlers deny that he ever
called Rodolfo Terragno but there was nothing accidental about Ken
Lay's courtship of the Bush Family.
Lay's ties to George H. W. Bush go back to 1980, when Bush made
his first bid for the White House. Bush, who'd recently served as direc-
"KENNY BOY"
87
tor of the Central Intelligence Agency, needed campaign funds after his
surprise win in the Iowa caucuses. So Lay, who had likely met Bush
through mutual friends in the energy business in Houston, gave money
to Bush's campaign. And though Bush didn't win, Ronald Reagan made
him vice president. Bush went on to chair the panel that pushed Reagan's task force on deregulation. One of Reagan's biggest moves in
deregulation involved the lifting of federal controls on natural gas markets, a move that Lay had long favored.
In April 1987, Lay reached into his pocket again for Bush, giving
him $1,000 (the maximum donation individuals can give to presidential candidates) for his 1988 presidential campaign. In October 1988,
when Bush's campaign was in its final days, Lay was one of the candidate's lead fund-raisers and chaired a $1,ooo-a-plate fund-raiser in
Houston for Bush.6
When the elder Bush got to the White House, he didn't forget Lay.
Bush rewarded Lay during his presidency with one of the most coveted
perks of being a presidential pal, a sleep-over at the White House.
By 1990, Lay had become a Big Shot in Houston, and a friend of the
Bushes, so he was selected to serve as a co-chairman of the host committee for the Economic Summit of Industrialized Nations in Houston.
At that affair, Lay got to rub elbows with the Bushes, as well as
Mikhail Gorbachev, Margaret Thatcher, and other world luminaries.
Two years later, when Bush was running for reelection, Lay
defended the president against some of his detractors in the energy
industry saying, "I'm a strong supporter of the president and his
administration. As an industry, we've pretty much gotten what we felt
we wanted ten or fifteen years ago." That was certainly true. In addition to the deregulation of the gas business, the Reagan and Bush
administrations repealed the windfall-profits tax on oil companies, a
levy that was instituted in the late 1970s when Big Oil made huge profits during the run-up of oil prices after Arab nations curtailed shipments of oil to the United States.
Also in 1992., George Bush personally asked Lay to head the Host
Committee for the Republican National Convention, which was held in
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Houston. And Lay made sure that Enron did its part. Lay's company
put up $2.50,000 to help the GOP defray the costs of confetti, streamers, and stupid hats during the convention. Although the Elder Bush
lost the 1992, election to Bill Clinton, Lay didn't disown the Bushes.
Instead, he took it as an opportunity to ingratiate himself even further.
Lay stepped forward in an (unsuccessful) effort to lure the outgoing
president's presidential library to Houston. That library effort, Lay
said, allowed him to spend "a little more quality time with George W."
That quality time turned into cash.
When Bush the Younger decided to run for governor of Texas in fall
1993, one of his first stops on the campaign trail was Houston. During
his visit, George W. Bush asked Lay to be the finance chairman of his
campaign in Harris County, which includes Houston. Lay didn't take
the job. He preferred to give George W. Bush a $12,500 check and
work behind the scenes. In his stead, Bush's campaign in the county
was headed by Lay's second in command at Enron, Rich Kinder. In all,
Lay, Kinder, and other Enron executives donated $146,500 to George
W. Bush, almost seven times more than the amount they gave to the
incumbent candidate, Democrat Ann Richards. The donations by the
execs, combined with money from Enron's political action committee,
made the Houston firm Bush's biggest campaign contributor. (Amazingly, after the Enron bankruptcy, George W. Bush would contend that
Lay was "a supporter of Ann Richards in my run in 1994.")
After George W. Bush defeated Richards, Enron gave $50,000 to
Bush's inaugural committee. Lay began lobbying Bush almost immediately. In December 1994, before Bush moved into the Governor's Mansion in downtown Austin, Lay began sending him regular letters on
energy policy, tax issues, lawsuit reform, and other matters. That
month, Lay asked Bush to appoint Pat Wood, who supported the
deregulation of electric utilities, to the state's Public Utility Commission. Bush complied with Lay's request. And later on, Bush would
appoint Woodagain at Lay's recommendationto the Federal Energy
Regulatory Commission. On December 21, 1994, Lay wrote Bush, saying tort reform was critically important to Texas and asked the gover-
"KENNY BOY"
89
nor-elect to make the matter the "highest priority during the early
months of your administration." Bush again complied, declaring tort
reform a state emergency, a move that gave the matter priority in the
Texas legislature. In 1997, Bush signed a tort reform bill into law that
limited jury awards in civil suits and narrowed the definition of liable
parties. But in an ironic twist, Enron also lobbied for a provision that
would have shielded accounting firms from being held responsible for
financial statements issued by the firms they audited. The provision
didn't make the final bill.
Some observers have said that Bush and Lay were not that close.
Instead, they point out that Lay and Bush were simply on parallel
wavelengths. Both men favored less government regulation, and both
believed private enterprise and free markets were the way to prosperity.
That may be the case, but it is also clear that the Bush-Lay relationship
is rife with examples of the two men doing favors for each other.
Shortly after taking office, George W. Bush began considering an
overhaul of the Texas tax code. He wanted to reduce property taxes
for homeowners and raise the state's sales tax by 8 percent. So he
formed a seventeen-member committee to study the issue. One of his
appointees was his Enron-based fund-raiser, Kinder. The committee
proposed a $3-billion package that would reduce taxes on capitalintensive industries, such as natural gas and petrochemical firms, while
shifting much of the burden onto service-oriented entities like doctors,
accountants, and attorneys. It also would have meant $9 million in
annual tax savings to Enron.
Kinder wasn't the only Enron delegate to get Bush's ear. In August
1995, when Bush was just beginning to formulate his tax scheme, he
held a private meeting with Charls E. Walker, a former deputy treasury
secretary in the Nixon administration who had also advised Ronald
Reagan on tax policy.7 Walker was chairman of Walker/Potter Associates, a lobbying firm in Washington, D.C. He also chaired the American Council for Capital Formation, a group funded by capital-intensive
industries. The group's Board of Directors included executives from
Shell Oil, Texaco, Exxon, and of course, Enron. During their meeting,
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Walker told Bush that the best way to encourage economic growth was
to reduce taxes on expensive plants and equipment because those factors drive productivity and economic expansion. Shortly after their
meeting, George W. Bush wrote Walker, saying, "Thank you for your
time and ideas. Bush budget director Albert Hawkins will follow up as
we develop our models." Bush's final plan was almost identical to the
approach Walker was advocating. Although Bush's "Texas business
tax" died in the Texas legislature in 1997, his meeting with Walker and
his willingness to advocate Walker's position indicates the kind of consideration Bush gave to Enron's point of view.
Why? At the time Bush met with him, Charls E. Walker was an
Enron board member and had been serving on the company's board for
ten years. And it was no coincidence that Walker was on the Enron
board. Charls E. Walker is the brother of Pinkney Walker, Ken Lay's
old economics professor. Pinkney Walker told me that Lay had asked
him first to be on Enron's board but he had declined and advised Lay to
hire his brother instead.8 In the two years prior to his meeting with
Bush, Walker, in addition to his duties as an Enron board member, was
working as a paid lobbyist for the company. In 1993, Walker's firm was
paid $31,146 for Enron-related lobby work. In 1994, Enron paid the
firm $39,750 for its lobby work.
When asked about his meetings with Walker, Bush told the Dallas
Morning News that he "would like to get him involved more on this
down here in Texas. He's very articulate." And though the paper didn't
ask about the Enron-Walker connection, Bush offered the comment
that he and the Enron lobbyist were "simpatico."9
Ah yes, simpatico. If Bush had been any more simpatico with
Enron, he could've been charged with a misdemeanor under the state of
Texas's buggery laws.
In addition to Bush the Younger, Lay continued to hold sway with
Bush the Elder. In summer 1996, Lay was pushing hard on a proposal
to build a new baseball stadium for the Houston Astros team, which
was threatening to seek bigger, better subsidies somewhere else. Houston voters, though, were wary. Just a few months earlier, they had
"KENNY BOY"
91
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Rebecca Mark wanted to get the Dabhol power plant built so badly she
could taste it.
Mark had been at Enron since the mid-1980s, and she needed to
make a big score. She needed something that would really impress the
people back in Houston. If she could just get the Indian government to
finalize the Dabhol deal, she'd make millions of dollars in bonuses, and
better yet, she'd finally be out of the shadow of John Wing, the man
who had taught her how to make big power deals.
By summer 1993, Mark had been working on the Indian project
nonstop for nearly eighteen months. And she was having good success.
In July 1992., Enron and the Maharashtra State Electricity Board had
signed a memorandum of understanding that laid out the basic terms:
Enron would build the power plant at Dabhol, about 150 miles south
of Bombay. Mark had the backing of Ken Lay and the somewhat lukewarm backing of Enron's president, Rich Kinder. On the surface, the
deal made some sense. India's population was growing, its economy
was becoming more stable, its workforce was highly educated, demand
for electric power, particularly reliable electric power, was growing, and
although the country had plenty of coal reserves, it was going to need
new energy sources that were fueled by natural gas.
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95
afternoon ski outfit, and yet another outfit for cocktails and dinner.
Mark certainly isn't shy about displaying the strength of her closets.
She bragged to one reporter that her costumes are "a bit of theater." As
for the high heels, she said they "make your legs look long when
they're not and make them look skinny when they're not."
From India to England and Argentina to Texas, Rebecca Mark was
a one-woman blitzkrieg whose only goal was to make gigantic deals
backed by even bigger promises. And yet in nearly every case, the deals
came with wallet-numbing losses. No one has blamed Mark for the fall
of Enron. It appears that she was not behind any of the off-the-balancesheet deals created by Jeff Skilling and Andy Fastow. But there is also
no question that the enormous losses Enron took on Mark's projects
accelerated the company's downfall. In addition to losses on the projects, Mark's high-living globe-trotting style was a constant drain on
Enron's cash coffers.
Rebecca Mark was Enron's rock star. And just like Britney Spears,
everyone has an opinion about her.
Opinions aside, there are a few facts about Mark that cannot be disputed: She could sell ice to Eskimos; she's pretty enough to be a model;
she's talented, speaks excellent Spanish, is a Harvard MBA, has a
wealth of knowledge about the energy business, and owns a Rolodex
filled with the names of important government officials in dozens of
foreign countries. And although she wasn't as ruthless as Skilling, she
was every bit as cunning and every bit as vain in her quest for power,
fame, and mountains of money.
Women are particularly scathing in their assessments of Mark.
Maybe it's because women have had a harder time making their way up
the corporate ladder than men. To succeed, women have, arguably, had
to be smarter, faster, and gutsier than their male counterparts. But the
anger of Mark's peers has a unique quality. Perhaps it's envy.
Maybe the women are jealous of Mark's money, success, and good
looks. Envious or not, they are clearly angry about what they consider
Mark's unflinching use of her sexuality to get where she got. One
prominent (female) energy analyst said of Mark, "She got to the top on
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her back." Women who worked at Enron are scarcely more charitable.
They roll their eyes whenever Mark's name is mentioned and almost
immediately mention (in appropriately hushed tones, of course) allegations of Mark's affairs with several male executives at the firm. The
only affair that Mark had at Enron that has been publicly acknowledged is her fling with John Wing.1 I'll get to that in a minute.
A prominent former (male) executive at Enron said admiringly of
Mark, "She's as good with her sexuality around men as anyone I've ever
seen. She knows how to flaunt it. She just knew how to use her intelligence and sexuality to her advantage when sitting across the table from
men who didn't know how to handle her." The man wasn't slamming
her. He made the comment in a complimentary fashion. And he added,
"She's a tremendously smart gal. But she's very scary because she only
cared about how much money she could make for Rebecca Mark."
Indeed, much of Mark's marketing campaign for herself depended
not on her brains but her butt. "I don't mind being remembered as,
'Oh, that's that beautiful woman I talked to,'" she told Forbes magazine in I998.2 The fawning profile, which included half a dozen photos
of Markin half a dozen different outfitsshowed her at the height of
her power and vanity. "People will make an appointment just to see if
you can walk and chew gum at the same time," she said. "I'll take all
the advantages I can get."3
One advantage that Mark had from the outset was that she was in
the right sector to get noticed. Many of her peers were in softer industries: Jill Barad was at toy maker Mattel; Charlotte Beers was at leading
ad agency Ogilvy & Mather Worldwide.4 Mark was in a business dominated by men who have always viewed their industry, and of course,
themselves, as macho. "If you want to make a name for yourself and
you are a woman, go to the energy business," commented one executive who knows Mark and worked with her. "I'd go to a conference
and there'd be ninety-nine guys and one woman. She had advantages
by being an oddity."
Although many of her male counterparts respected her intellect,
they also questioned her motives. One executive who worked with her
97
Rebecca Mark wasn't born into a world of high finance and international power projects, but she managed to grow accustomed to them
awfully fast. She was born Rebecca Pulliam in Kirksville, Missouri, in
1954. Her parents were farmers, and she spent much of her youth
learning the value of hard work and manual labor. One of four children, she baled hay and worked in the fields. Mark attended Kirksville
High School, where she was a member of the National Honor Society
and was one of four students selected for Girl's State, an American
Legion-sponsored, weeklong event in which the students experience a
"mock government situation," the idea being to learn about government and citizenship. Joellen Hayes, the librarian at Kirksville High,
remembered Mark. "She had big dark eyes and wore her hair long and
straight. She was a beautiful girl. She was not terribly outgoingmore
quiet and reserved, and highly respected by teachers. She was just a
very pleasant, mature-acting girl."
After high school, she attended William Jewell College, a private
Baptist college near Kansas City. From there, she went to Baylor University, in Waco, Texas, where she got an undergraduate degree in psychology and a master's in international management. After graduation,
she worked for First City National Bank of Houston, one of many big
Texas banks that are now owned by megabanks on the East or West
Coast. Along the way, she married Thomas Mark, and together they
had twin sons. In 1982, she jumped into the energy business by joining
the treasury department at Continental Resources, a natural gas
pipeline company. In 1985, Continental was bought by Houston Natural Gas, and Mark's sojourn into the manly world of energy began.
Mark had been at HNG for several years when she began having an
affair with her boss, Wing, who was heading Enron's electric power
division.5 The former army captain put Mark through what one person
compared to his own private business boot camp. "Wing treated her
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like a drill sergeant would treat a young private," recalled one executive. "He'd fire her publicly. He'd ridicule her on conference calls, treat
her like a secretary, dress her down. He basically had her psychologically from any perspective."
"She had a lay-down sexual harassment suit if she had wanted it.
Yet at the same time, they're having an affair," said the executive. "You
didn't feel comfortable being around them. But you were more uncomfortable because they were having an affair."
While Wing was berating Mark in the board room and boffing her
in the bedroom, he was also showing her how to get deals done in the
international electricity market, which was just beginning to open up
to foreign investors. He tutored her on the details of the Teesside
power plant in England. That schooling provided the groundwork for
Mark's ascendance within Enron. In 1988, she and Thomas Mark
split. The divorce left her with custody of the couple's twin sons.
About that same time, she left Enron to attend Harvard Business
School. While attending Harvardcourtesy of Enron, which paid her
tuition and reportedly even paid for her child careshe helped monitor the construction of an Enron power plant in Milford, Massachusetts. The Milford plant later became infamous inside Enron because of
two rather sticky problems: The plant didn't have access to enough gas
or enough water. But Enron wanted the plant built and built by Mark,
so she made sure to get the project completed. It was sold a few years
after it was built for a slight profit.
After graduating from Harvard, Mark came back to Enron ready to
set the world on fire. Within a few months of her return, she convinced
Ken Lay that there were many more opportunities on the international
front than just the Teesside project in England. So the company created
Enron Development Corporation and in 1991, Mark was named CEO.
That position led Mark to pursue projects from Qatar to Turkey. Without question, though, the most important project was Dabhol.
Foreign investors had shied away from India for a simple reason:
The country's politics were in nearly constant turmoil. And that turmoil
scared investors. If they invested in a big project and the Congress
99
Party, the ruling party in India for nearly half a century, was suddenly
thrown out of office, there were no assurances that their money would
be returned. Beyond that, India had long despised foreign investment as
an insult to the country's self-sufficiency. It was a belief that came from
three and a half centuries of experience with outfits like the British East
India Company and the Brits who came with it. Foreign companies
were colonizers just like the British, and the Indians had already seen
plenty of that, thank you very much.
In addition to the political risk, there were huge capital risks. Enron,
along with its partners, General Electric and construction giant Bechtel,
were proposing a 2,015-megawatt power plant that would cost about
$2.9 billion. It would be built in two phases. Phase One of the project
would burn naphtha, a fuel similar to kerosene and gasoline. The 740megawatt power plant would help stabilize the local transmission grid
and provide infrastructure for the more expensive second phase. Phase
Two meant liquefied natural gas, or LNG, and LNG infrastructure is
very expensive. The fuel can only be moved by refrigerated tankers that
cost hundreds of millions of dollars each. The infrastructure associated
with the LNG terminal at Dabhol was going to be about $1 billion.
That overhead and the cost of making LNG (it has to be frozen) and
transporting it meant that Dabhol's fuel costs were likely going to be
about $500 million per year.6
Despite the high costs, Mark and Enron believed LNG would be
their foothold in India. After Dabhol got up and running, the company
planned to build a pipeline north to Bombay to carry gas from the
LNG terminal to other power plants or big industrial customers. Indian
officials were also interested in having a new LNG supply to augment
their existing energy supplies. The Indian government was excited
about Enron's project. Not only would it help stabilize the country's
overtaxed power grid, but it would provide a reliable source of power
that could attract new foreign investment to the western coast of India,
particularly new industries. Sure, the plant was going to benefit Enron,
but if it could be built at the right price, it would be very good for
India, too.
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And though Indian politics, logistics, and other factors were important, the final justification of Dabhol was really very simple. Mark and
her fellow Enron employees had to answer two key questions: Did India
really need the power? And, more important, could India pay for it?
The answers were probably, and probably not.
India, with about 1 billion people, has nearly four times as many residents as the United States. Most of them are desperately poor. According to the World Bank, the average per capita income in India is just
$450. That means that the vast majority of Indians cannot afford electric appliances or the electricity needed to run them. That fact shows up
in the country's electricity consumption figures. Although India has
four times as many people as the United States, it consumes about oneeighth as much electricity.
And when Indian residents do consume electricity, they often don't
pay for it. When they do pay, it is often at prices that are far below the
actual cost of producing the power. In his excellent book on the Dabhol
project, Power Play: A Study of the Enron Project, Indian journalist
Abhay Mehta estimated that in the Indian city of Delhi, about 54 percent of the power consumed in the city is simply stolen. Some of the
theft in Delhi and elsewhere is by slum dwellers who illegally tap into
nearby power lines, but much of it is committed by affluent Indians
whose homes do not have electric meters or by industrial companies
eager to cut costs. In other cases, the power is not actually stolen, but
residents and companies pay a fixed rate for their power that covers
only a fraction of the real cost of electricity they consume. In the state
of Maharashtra, where Enron was building Dabhol, Mehta reports that
the official estimate of the amount of power that was stolen was 15.7
percent. "However, since nearly 40 per cent of the total generation of
electricity in Maharashtra is supplied without any metering, it is quite
likely that the real losses are much higher than the official figure,"
wrote Mehta.7 "A realistic estimate of Maharashtra's T&D [transmission and distribution] losses would probably be around 30 per cent."
101
Enron officials knew about the power-theft problem when they were
negotiating the contract. "The ones who steal the power are the farmers," said an Enron official who worked in India. "They make up half
the electric base in every state. So if you anger them, you don't get
elected. The state doesn't do anything about the theft because it would
be highly unpopular.... The Maharashtra State Electricity Board officials talked about the theft all the time. It's a weekly story in the newspapers there."
The theft of power provides critically important context for the
Dabhol project. Who would be crazy enough to build a power plant in
a place where 30 percent (or more) of the plant's output was simply
going to disappear?
The World Bank thought Dabhol was a bad project and refused to
finance it. On April 30, 1993, the huge lending agency sent a letter to
Indian authorities that said the Enron project was "too large for base
load operation" in Maharashtra. 8 The agency said coal was a better
and lower-cost fuel than LNG for producing electricity in the region
and that replacing coal-fired electricity with LNG-fired power from
Dabhol "would place a heavy financial burden on" the Maharashtra
State Electricity Board. The letter went on to say that "local coal and
gas are the preferred choices for base load generation."9 It added that
"implementation of the project would place a significant long-term
claim on India's foreign exchange resources."10
The World Bank report was bad news for Enron. "I think the Bank
has a major role to play, so we would like to have their concurrence,"
Mark told one reporter. But she was quick to add that Enron didn't
have to have the World Bank's approval to proceed with the project.
And that's exactly what Enron did. A few weeks after the World Bank
report came out, Mark's chief lieutenant at Enron, Joe Sutton, a macho,
hard-driving former army officer who wasn't used to being told no,
wrote a member of the Maharashtra State Electricity Board, saying that
Enron was going to hire a public relations firm that would "manage the
media from here o n . . . . The project has solid support from all other
agencies in Washington. We'll get there!"
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Mark and Sutton pushed on with the project. And on August z6,
1993, Mark faxed a letter to Sharad Pawar, the chief minister in the
state of Maharashtra, that showed her blind determination to get the
Dabhol deal done. She began by saying that Enron officials had been
meeting with officials from Maharashtra and the country's main electric power agency, "to answer their questions about the project. The
remaining concern," she said, was a state official named Mr. Beg, who
"continues to hold up project approval based upon the question of
demand for power in Maharashtra. No one from the Ministry of Power
in Delhi has given direction to Mr. Beg to move forward on this issue"
(emphasis added).11
Mark went on to say that it was critical that Indian officials sign a
power purchase agreement so that Enron could begin financing the
project. She concluded, "We are working on financing arrangements
prior [to] project approval but the banks in India and externally are
losing their enthusiasm based on lack of progress
We need to make
immediate progress."
Mark didn't know it at the time, but her letter would prove to be
the key document in the story of Dabhol. In it, she is telling Pawar
there was no reason for people like Mr. Beg to delay the project based
on silly matters like "demand for power in Maharashtra." More
important matters like financing needed to be attended to. The message
was clear: Forget about questions about who will use the power and
how much they might pay. Never mind about demand questions. Never
mind if the power from Dabhol is actually needed. Sign the damn
papers and get moving. We'll deal with those other questions later.
By early December 1993, Mark had all the signatures she needed.
Enron had a deal for Phase One of the project. The Indian government
had signed a contract that required it to pay Enron about $1.3 billion
per year, or about $26 billion over the life of the twenty-year contract.
It was, Mehta said, one of the largest civilian or military contracts ever
signed, anywhere on the globe. And it was surely the largest contract
ever signed in India. Over the life of the contract, India would pay
Enron and its partners nearly nine times what Dabhol had cost. Fur-
103
thermore, India was required to pay for any cost increases caused by
price hikes associated with the plant's fuel, electricity transmission
lines, or plant maintenance.12
The final insult of the contract was a stipulation that required India
to pay Enron in American dollars, even though the Indian rupee was
undergoing regular depreciation. Mark had negotiated a can't-lose contract in which fluctuations in international currency and fuel costs
would have no impact on Enron and its partners.
The deal really was too good to be true. And to cement it in place,
Enron needed help from an obscure but very powerful federal agency.
1994
105
political platform from which the president and his appointees can
affect foreign investment, and therefore foreign policy. The president
also gets lots of new friends with deep pockets in corporate America
who covet OPIC's backing. Once those corporations have OPIC's backing, they never have to worry about the agency going bankrupt. That's
because OPIC is backed by the full faith and credit of the United States
of America.
OPIC is a self-sustaining organization, meaning it doesn't draw
operating funds from the U.S. Treasury, but it also has another important quality: It helps presidents raise campaign money. More on that in
a moment.
OPIC's sway goes far beyond the ability to lend money or provide
insurance. OPIC acts as a financial gatekeeper. If OPIC's Board of
Directors approves a project, "it sends a signal to the private-sector
financial markets," said former OPIC staffer Jon Sohn. "OPIC
approval is like the ultimate seal of approval for other international
lenders." Indeed, many international banks and insurers require OPIC's
involvement in projects before they will sign on.
The argument in favor of agencies like OPIC is that they stimulate
economic activity in both the lending country and the receiving company. In addition, OPIC and similar agencies in Japan, Germany, and
elsewhere, with their burly backers, are able to finance or insure deals
that commercial banks or insurers couldn't. The arguments for OPIC
say the agency serves America's interests. When American companies
get projects built overseas, those projects benefit American shareholders. They may also provide jobs and investment opportunities for
Americans. Further, if American companies are going to compete for
international projects, they are going to have to compete with foreign
companies that have ready access to insurance and loans from their
governments.
American companies can count on OPIC to keep their secrets.
Although the agency is backed by American taxpayers, the agency's
board operates under a veil of secrecy. The agency insists that the minutes of OPIC's closed-door board meetingsduring which the agency
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109
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PIPE DREAMS
Cheney became the chairman and CEO of oil field and construction
services giant Halliburton. According to the Center for Public Integrity,
in the five years prior to Cheney's arrival at the company, Halliburton
had garnered only about $100 million in loans and guarantees from
OPIC and a similar government-sponsored agency, the Export-Import
Bank.4 In the five years after his arrival, Halliburton received $1.5 billion worth of assistance from those same two entities.
Lay and Cheney both clearly understood the value for their companies of having their projects backed by the U.S. government. That government backing would play a major role in Enron's final days.
Throughout the early and mid-1990s, Enron grew steadily. And the
egos of the key players grew right along with it. Rebecca Mark was
gaining stature in the international electricity business. Jeff Skilling was
becoming a force in the trading world. But everyone at Enron knew
who really ran the company. It wasn't Ken Lay.
Sure, Lay had the titles of chairman and chief executive officer, but
the real management of Enron was done by Rich Kinder, the guy who
made sure the mundane stuff was taken care of. By early 1996, Kinder
was at the height of his power. And he demonstrated that power every
Monday morning. The meetings were held in the board room on the
fiftieth floor of the Enron building. Every unit leader at Enron, from
pipelines to power plants, was expected to show up, ready for grilling.
Ken Lay was usually there, but it was Kinder's meeting. As the president and chief operating officer of Enron, Kinder (pronounced KINNder) was the boss. And he wasn't shy about reminding everyone in
attendance of that fact. He demanded that every business unit leader be
ready with all the numbers, plans, and strategies for their areas of
responsibility.
"Every Monday, I knew exactly how much money my pipeline had
made so far that year and had estimates in hand for what it would pro-
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duce during the rest of the year," said one top executive who worked
under Kinder. And although Kinder was a lawyer by training, not an
accountant, he was a master moneyman. Everyone who worked with
Kinder at Enron marveled at his ability to memorize details of contracts
and prices, even though the deals might have been made many years
earlier. His recall for facts and figures was legendary. "You could give
him a budget number and explain where it came from and he'd say
'that's not what you told me last year.' And then he'd go to his desk and
retrieve the year-earlier budget and prove you wrong. It was amazing,"
said one lawyer who worked under Kinder. Despite all of the reports
and information Kinder had to track, he only kept two file-cabinet
drawers filled with important data. The rest of the numbers he kept in
his head.
When presented with proposals, Kinder would quickly zero in on
the deal's weakest point and demand an explanation. "Rich didn't care
if you had a great story. He wanted to know several things: How do
you plan to make money? How do you secure your risk? And how do
you assure your cash flow? It's a simple focus, but it can encompass a
lot of things. You could give him a 5oo-page deal and he would pick
out the one number you can't explain," recalled a finance executive
who worked at Enron. "He was impossible to bullshit. A lot of people
at Enron would lie about their numbers. And at that point, Rich would
eat them for lunch."
Kinder had plenty of big snacks during his tenure as president and
COO of Enron, which lasted from 1990 to 1996. One former employee
called him "Doctor Discipline." That disciplined approach was just
what Enron needed. Low natural gas prices and high debt were stifling
Enron's growth. But Kinder remained focused on reducing debt and
maintaining the company's credit rating. During his first three years as
president, he paid off nearly $1 billion of the company's loans.
On any expenditure, Kinder acted "like the money was coming out
of his own personal checkbook," said Alberto Gude, a former vice
president of information systems who worked with both Kinder and
Jeff Skilling.
Iq97
2q97
3q97
4q97
Iq98
2q98
3q98
4q98
Iq99
-142
-523
-588
501
50
-251
-29
1,640
-660
Revenues
20,273
2q99
3q99
4q99
-38
-43
1,228
31,260
40,112
Iq00
2qOO
3qOO
4qOO
Iq0l
2q01
3q01
-457
-547
127
4,779
-464
-1,337
-753
100,789
50,129
100,189
138,718
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PIPE DREAMS
Kinder's obsessions were cash and cash flow. Bonuses for business
unit leaders were often tied to their ability to meet cash flow projections, and each unit was given earnings targets and cash flow targets. In
addition to his fiscal conservatism, Kinder was clearly focused on
Enron's business model and made sure the company didn't stray too far
away from the businessespipelines, exploration, and production and
gas processingthat it knew and knew to be profitable. With Kinder,
"it wasn't enough to just get into a new business, you had to have a
strategy that was going to be a natural outgrowth of your existing business. He was a detail person. He wanted to know if there were growth
areas, it had to be logical, thought out and have a good reason behind
it," said Mike Moran, an attorney who worked at Enron for nearly
three decades. Moran and others recalled that Kinder used an oftrepeated line whenever Enron managers would get too cocky or assume
that their projects were bound to succeed. "He'd say, 'Let's not start
smoking our own dope.'"
In addition to his strength in managing numbers and businesses,
Kinder was loyal to people inside Enron. He maintained a collegial
atmosphere within the company and went out of his way to show
respect for employees. One pilot who spent more than two decades
working for Enron said that after his wife died, Kinder "came to my
rescue. He flew my family home from Nebraska. He wrote me a personal letter. He took me under his wing. I have a great deal of respect
for Rich Kinder."
His personality and management strengths made him the perfect
match for Ken Lay. Kinder was "Mr. Inside." Lay was "Mr. Outside."
The combination suited both of them just fine. While Lay gave speeches
and posed for pictures, Kinder ran the company. He mastered the
details of every business, from trading to natural gas liquids, and his
knowledge fostered trust inside and outside the company. He handled
all the company's negotiations with the rating agencies, the bankers,
and Wall Street analysts. "If you get in a room with him, you are really
attracted to him," said one Wall Street analyst who has known Kinder
for several years. "He knows everybody in Houston and every energy
player in the country."
115
Ken Lay and Rich Kinder reportedly met while attending the University
of Missouri in the early 19608. After Lay graduated, he went to work
in the oil business. Kinder, who got his law degree from Missouri,
reportedly began practicing law in that state. In 1980, Kinder got hired
at Florida Gas, according to sources, with help from Ken Lay. Kinder
worked on a number of issues at Florida Gas. The two separated when
Lay went to Transco. But when Lay got to HNG, one of his first acquisitions was the purchase of Florida Gas, a move that brought Kinder
and Lay back together.
After the 1985 merger with Internorth, Kinder began making himself increasingly indispensable. Shortly after the merger, he became general counsel and chief of staff. In late 1988, he was named vice
chairman of the Board of Directors. Enron's press release announcing
the promotion said Kinder's prior jobs included "finance and accounting, law, administration, human resources, management information
systems, corporate development and corporate affairs," adding that
"he will retain these responsibilities in his new post."
Given all Kinder's duties, it was becoming clear that Enron's president and chief operating officer, Mick Seidl, didn't have much to do.
"Seidl was a nice guy but he was never engaged to the degree Kinder
was," said one executive who worked under both men. Another commented that Seidl was simply "too nice" to be in a position where he
had to make tough business decisions. Furthermore, there was a feeling
that someone at Enron had to take the fall for the trading disaster in
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PIPE DREAMS
117
Wing, who were working on foreign power deals like the Teesside project in England.
By the early 1990s, things could scarcely have worked better for
Kinder. All of the executives knew their roles and they worked well,
according to executives who worked on that team. While Kinder drove
the numbers side, Lay acted as the inspirational leader. He "had the
ability to take prima donnas and get them to hover around a central
theme," one executive from that group recalled. "Without Ken, they
would have exploded into a million different directions." While Lay
inspired the troops, Kinder kept the egosand the budgetsin balance.
Under Kinder, Enron launched a number of successful businesses
and projects. The electric power businesses showed phenomenal
growth under Kinder. The pipelines showed moderate but steady
growth and provided reliable cash. The gas and electric power trading
business headed by Jeff Skillingenjoyed frenetic expansion and
good profitability in their early days. Kinder's slow-but-steady
approach was successful, but he had his foibles. In fact, he repeated one
of Ken Lay's mistakes: He began sleeping with the hired help.
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PIPE DREAMS
why McNeil was moved upstairs, one source close to the matter
remembered. "But everybody knew it was because she was sleeping
with Rich." One secretary recalled that shortly after Kinder divorced
his wife, Anne, he told several people in a staff meeting that he and
McNeil were "going to try dating." The joke among the women at
Enron, she said, was that the two "might as well 'try dating.' They've
tried everything else."
Several executives who worked with the two men says the news of
the Kinder-McNeil affair immediately caused a rift between Kinder and
Lay. Lay became more suspicious of Kinder and began wondering what
McNeil had told him about Lay's own dealings, appointments, and decisions. The affair "created a wedge between them," said one source. And
although Lay and Kinder were able to maintain cordial relations, there
"wasn't much of a relationship between them after that." Another executive said that shortly before the Kinder-McNeil affair was acknowledged, Lay asked Kinder whether he was sleeping with McNeil. Kinder
reportedly denied having an affair with McNeil. "After that, Ken lost
any trust in Rich, and that meant that Rich wasn't going to be CEO."
The affair with McNeil undoubtedly hastened Kinder's departure
from Enron. Staying at Enron while continuing his affair with McNeil
didn't appear to be an option. The awkwardness of any social gathering with the other executives would have been too much for any of
them to handle. In addition, the board and Lay were in discussions
about Lay's future. Sources close to Lay and Kinder say that in 1992.,
the two men agreed that Kinder would ascend to the CEO job in five
years. Under the agreement, Lay would stay on as chairman of the
company, but Kinder would be in control of all real decisionmaking at
Enron. But by late 1996, Lay and the board reneged on that deal. Lay
would stay on as CEO for another five years.
In late 1996, when told about the decision, Kinder accepted it
quickly and tendered his resignation. He told another Enron executive
that he had no choice. "If you aren't the lead dog, the scenery never
changes," said Kinder. While he didn't become the lead dog, Enron
threw him some meaty bones, including $109,472. in vacation pay, $1.1
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1997
121
ates and analysts would then be left to find a home within the company. If they couldn't find a spot, they were out.
Most of the analysts and associates did find a home at Enron, and
once inside the polished chrome and glass doors, the best and the
brightest talked fast, worked insanely long hours, traveled first class,
made lots of money, and did all those things among their peers. Every
one of them was smart, motivated, and ready to get ahead. Enron provided every amenity to keep them happyand working. The Enron
building had a health club with every imaginable contraption; a
concierge, who, for a fee, would handle errands and personal matters; a
massage service; a credit union; and, of course, a Starbucks to keep
everyone caffeinated.
The health insurance, pension, and other benefits were good, the
environment relentlessly competitive. Rotations in good jobs, in areas
where real money could be made, like trading and project development,
were highly coveted. But there were plenty of other opportunities, particularly working overseas. Want to work in the London office? Go
ahead. Be sure to fly in first class.
The competition began in the hiring process. Enron wanted young
aggressive people who were ready to take over right away and make
deals and decisions. People who needed lots of hand-holding belonged
at Exxon or Texaco, or the other old-school energy companies. Enron
wanted people who were in a hurry. And that attitude prevailed during
what the company called "Super Saturdays," when Enron would interview prospective candidates. Every recruit would sit through eight consecutive fifty-minute-long interviews during which they were scored
from1 to 5 on such factors as intelligence, analytical skill, and aggressiveness. The best and brightest of that group were offered starting
salaries of $60,000 to $100,000. Fat bonuses could increase those figures by 30 percent or more.
Enron's caste system was clearly delineated from the beginning. One
man, who had a master's in economics from the University of Oklahoma, wanted to get into the analyst and associate program but was
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instead placed in the risk management group, where he evaluated projects being pushed by peers who were likely to make two to ten times
more money than he was making if they could get their projects
approved. "I didn't go to the right school," he said. "I was told OU
wasn't worthy of the program. The people who'd gone to the Ivy
League schools or the big-name schools were paid more and given better jobs." And it was not uncommon for the new hires to remind their
coworkers that they'd gone to Harvard or another top-flight school.
The OU graduate remembered that shortly after he was hired at Enron,
a group of a dozen or so people were introducing themselves to each
other. During those introductions, one very proud young woman volunteered, "I went to Thunderbird [the American Graduate School of
International Management, in Glendale, Arizona]," she said, "the best
international business school in the country."
The fleet of newly hired hotshots were never short of confidence or
the belief that they were working at the best, smartest, fastest-moving
company in the world. One longtime Enron employee (who held a Ph.D.
from the University of Maryland) said, "There's no question that Enron
people arrogantly thought they were smarter than everybody else.
There's no excuse for that. But they were smarter than everybody else."
In addition to being smarter, Skilling's new crowd was far younger
than the old Enron culture. Enron "went from being a regulated utility
where nearly all the vice presidents were in their forties and fifties to a
company that was dominated by a huge number of younger, affluent,
well-educated traders and analysts and managers," said George Strong,
a lobbyist who worked for Enron for more than two decades. "It was a
different ball game."
With the crowd of twenty- and thirty-somethings came a cocksure
arrogance that no matter how complex the problemwhether it was
how to address price fluctuations in world paper markets or deal with
currency risks on a power plant in ChinaEnron employees could handle it. It was a belief that was fostered by the training they got in business school, where case studies are a major component of the
curriculum. Teams of students are often given a set of problems facing a
123
certain company and are told to come back in a few days with a report
identifying the solutions. That approach, said one former Enron
employee, "trains people to believe everything they need to know can
be boiled down into four pages and that all problems can be solved by
a few smart people overnight. That's not the real world. In business,
there are more wrong answers than right answers."
Right or wrong, the legions of newly hired hotshots believed they
held the keys to the kingdom. They were going to get rich and, in the
process, teach the rest of the world a few lessons. It was an attitude that
perfectly reflected that of Jeff Skilling and his cronies, who wanted
Enron to focus on deals and trading. By late 1998, Skilling's inner circle
consisted almost entirely of people who loved the trading business: people like Lou Pai and Kevin Hannon, who helped set up the original
trading operation in the gas business, and Ken Rice and Andy Fastow,
who had been working with Skilling for many years. They had been
trained to think, and act, like traders. And anyone who wanted to rise
to the top at Enron had to mimic their outlook.
It was an outlook that clashed with the old Enron, where loyalty
and friendsmattered.
Skilling's trader-dominated culture clashed violently with the one established by his predecessor. Under Rich Kinder, Enron fostered a culture
that respected, and tried to build, relationships with customers.
"You had the old pipeliners and you had the New York-type financial traders. They were at the opposite ends of the spectrum," remarked
one executive who worked with Skilling for much of the 1990s. After
Kinder left, all the old pipeline people were viewed as dinosaurs. It
didn't matter to the Skilling people that the pipelines always made
moneythat is, real cashtheir business was old, stodgy, and really
not worth talking about. The pipelines and the people who worked on
them became the ugly stepchildren at Enron.
"Nothing mattered to the New York traders except the deal," said
the executive. When Enron was controlled by pipeline guys like Kinder,
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"it was a relationship business and you did favors for friends. Once
Skilling changed Enron into a trading company, relationships counted
for zero. Zip. Nada. Nothing. It's 'show me the money.' It's the difference between doing a deal over lunch or over the telephone."
Another longtime Enron executive who left the company in the mid1990s said, "Skilling never gave a damn about customers' feelings. He
said, 'They'll do it if the price is right.'" The source also recalled
Skilling saying, "'Relationships don't matter. Trust doesn't matter.' I
think he honestly felt that."
Several executives at Enron worried that the trade-first-makefriends-later attitude would hurt the company over the long term. "My
idea was, you never screwed somebody on a deal. Why? Because they
would always spend the rest of their lives trying to get you back," said
one of Skilling's former coworkers. "Under the Skilling culture, a deal
was a deal. If I screw you, too bad. Shame on you. The problem is you
run out of people to do business with after a while because there are
only so many people in the market."
The lingo even changed. Under Kinder, Enron had "customers."
Under Skilling, Enron had "counterparties." As the lingo changed, so
did old-fashioned ideas like loyalty. Under Kinder, Enron had a more
family-based culture in which workers believed their contributions
were valued. In return, they were loyal, not just to Kinder and Ken Lay,
but to Enron and to each other. As one executive who worked under
Kinder said, "When push comes to shove, you can't buy loyalty, you
have to instill it in people."
But with Jeff Skilling at the helm, loyalty became a commodity that
was bought and sold just like gas, oil, and electricity. He even bragged
about it. On one occasion, Skilling told a top Enron executive, Terry
Thorn, the company's head of governmental affairs, "I've thought
about this a lot, and all that matters is money. You buy loyalty with
money. Don't ever forget that."
Given his attitude toward loyalty, it's not surprising that Skilling
liked being around traders. "Traders are mercenaries. Their job is to
kill. And mercenaries, by definition, don't have any loyalty," said Dan
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Ryser, who worked at Enron in the early 1990s before going to work
for Enron's hometown rival in the gas business, Dynegy Inc. "With
traders, it's rape, pillage, and plunder all the time. They don't care
about the shareholders or the business strategy or the long-term interests of the company."
That kind of mindset was pervasive among Enron's traders and deal
makers. They didn't want to know about complex issues, they wanted
to establish the prices needed to make a deal work. Once those prices
were obtained, they wanted to do the deal right away, because if they
did the dealgood or badtheir bonus would almost certainly be bigger because of it. That mercenary culture began to pervade everything
at Enron. Project developers would refuse to share the details of their
projects, lest another developer steal the projectand the bonus that
went with it.
The culture at Enron had shifted, and it had shifted in the exact way
that Jeff Skilling wanted. And nothing personified the company's testosterone-and-espresso-steeped culture better than the Performance
Review Committee.
The meeting was over before it had a chance to begin. The executives in
the room were all managing directors, which in Enron parlance meant
they were above the vice presidents and just below officer level. They
were meeting in a crowded conference room in the Enron building to
rank all of the executives who worked just below them, a group that
included several dozen people.
Before the first name had even been brought up, Enron's chief financial officer, Andrew Fastow, declared, "I'm not going to vote for any
employee that I don't know." Even by the cutthroat standards of
Enron, Fastow's move was so in-your-face that every managing director
in the room was immediately enraged.
"You heard this big 'Oh, man'-kind-of-groan from everybody in the
room because we knew that it was basically blackmail," said a source
who attended the mid-1999 meeting. Fastow "was saying, 'I'll shut the
whole thing down until you go my way.'"
Enron's Performance Review Committee, evil as it was, depended
on a modicum of civility and collegiality among the people in the
process. Each person doing the ranking had to be willing to barter and
trade. If one person knew an employee and thought he or she was a
good worker, then the person would vouch for the employee. And if the
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others didn't know the person, they had to be willing to trust their peer,
accept the assessment, rank the employee, and move on. Without that,
the PRC simply couldn't work. But someone had apparently irritated
Fastow that morning. He was mad. And he was adamant. "I'm not voting for anyone I don't know," he repeated.
"The meeting pretty much ended right then," said the source. "He
was saying, 'I don't trust you or believe you, your word is nothing to
me.' We couldn't do anything after that. Either Fastow had to cool off,
or we had to have a different group do the ranking."
Welcome to the wacky world of the PRC, which was also known by
its more colorful name of "rank and yank" or by another moniker, "bag
'em and tag 'em." The system was simple: The company's managers had
to rank every person in their business unit on a scale of I to 5.
Get a I and you're Madonna with an attitude. Get a 5 and you're
mopping the floor at McDonald's.
First implemented at Enron during the early 1990s, the PRC had the
desired effect when it was used on a small scale. Skilling's business unit,
Enron Gas Services, instituted the PRC to help get rid of some of the
employees left over from the HNG-InterNorth merger. Many of those
employees, once they rose to a certain level, knew that they'd probably
never get another meaningful raise, but they'd also probably never get
fired, either. The PRC changed that. Hundreds of people who had
become part of Enron during the merger were suddenly facing a choice:
Perform better or get a new job. "At the time, it was a great tool," a
source who worked closely with Skilling recalled. "When we started
the ranking process, we were trying to weed out the lower 5 or 6 percent of the company. We had some old dinosaurs, and we had some
younger people who needed incentives."
In 1997, when Skilling was promoted to president and chief operating officer, the PRC was gradually instituted companywide. The PRC
undoubtedly helped Enron get rid of underperforming employees and
create a more aggressive culture. It also spawned a gangrene-like rot
that allowed Enron to cannibalize itself.
The PRC created a highly politicized work environment in which, as
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one employee recalls, "It didn't matter how good you were. It only
mattered who you knew." Another employee called it an "institutionalized popularity contest." Another said that with the PRC, every
employee "had to find a 'daddy,'" that is, someone to protect them
throughout the process. "Everybody who was smart realized that doing
a good job was just the beginning. If you went home without working
the political system at Enron, you were toast. You had to find a daddy
to take care of you. And that person needed to be connected."
The process also created a Sisyphean task for Enron's managers,
who had to comb through the mountains of paper generated by the
PRC every year. Every employee had to be gradedon paperby several peers. And each of those peers had to be gradedon paperby his
or her peers. All of those assessments were then handed to the nexthigher level of managers, who were themselves being graded on
paperby their peers. The assessment process required each employee
to grade peers on such qualities as leadership, technical ability, and revenue generation. The assessments wasted reams of paper, which all had
to be passed among various departments and managers. "I'd get
swamped with surveys," said one former executive. "I had probably
forty direct reports, so I'm reading 400 different surveys. The PRC
would take two months of my time. I couldn't see the cost benefit of
the whole process. We had the TV sets in the building blaring out all
this propaganda on the four values. [Enron's four values were included
in the acronym RICE: Respect, Integrity, Communication, and Excellence.] It was Orwellian. You start to be cynical." The PRC system, he
said, "just bred more and more cynicism."
Finally, and perhaps most important, the PRC perverted Enron's
internal risk management systems, the processes that were supposed to
keep Enron from getting into lousy deals. The corruption of that
process would cost Enron millionsperhaps even billionsof dollars.
Despite widespread hatred of the system inside Enron's headquarters, Skilling thought it was great. He told one reporter, "The performance evaluation was the most important thing for forging a new
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strategy and culture at Enron it is the glue that holds the company
together."1
Skilling couldn't have been more wrong. The PRC wasn't glue. It
was poison.
The PRC created a culture within Enron that replaced cooperation with
competition. "Have you ever seen a team win that wasn't a team?" asks
one former Enron employee. "If you have a baseball team or a basketball team with a bunch of superstars on it, they don't win. But if you
get a bunch of role players, who understand their jobs, they win championships." The problem with the PRC, said the employee, was that it
"didn't reward the grinders." In his opinion, every company needs people who do the thankless jobs, the unglamorous jobs, like sending out
invoices, delivering mail, handling payroll. Enron needed those people,
too, but instead of letting them do their jobs to the best of their ability,
those people were put through the PRC. The result was that many people who were in the service part of Enron simply began creating work
to make themselves look better.
Among managers, said one former member of the company's Executive Committee, the PRC became "a great way to stifle dissent and create your own power base. It was used to reward your friends and
punish people that weren't."
Although the process was designed to advance the careers of top
performers and punish the low performers, it quickly mutated into a
numbers game. Every group within Enron had a limited pool of dollars
available for salaries and bonuses. The people who were rated I's and
z's were golden. "It was all based on how much money you were able
to make," said one source. With millions of dollars at stake in each
annual rating, the fights over individual rankings became intense. "It
was a pit of vipers. You can't believe how brutal that process could be.
You had people attacking other people's integrity, morality, and values.
It wasn't about supporting up, it was about tearing down."
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faster a deal maker could get a deal approved, the sooner that deal
maker could get a big bonus, buy the BMW, and go skiing in the Alps.
Therefore, speed was essential to every dealmaker and the RAC was
only capable of gumming up projects, not accelerating them.
"No one ever wanted to stand in front of a deal because you could
get killed in the PRC," recalled one source who spent several years in
the RAC. People who questioned deals "would get attacked by the
business units because they weren't as cooperative on a deal as the
developers wanted." In addition, members of the RAC had to fear retribution if they ever wanted to work in other parts of Enron after leaving
RAC. "You'd have a hard time finding another rotation if you were too
hard on certain deals."
Said another member of RAC, "We did our job. We did it well. But
it's like making a meal, and you throw it in the garbage. It was a fagade
for Skilling to point to when he wanted to impress the rating agencies
and the banks and outside investors. In the end, the RAC was destined
to fail because the traders' bonus incentives ran counter to what we
were trying to do."
The PRC became an ongoing, in-house inquisition, one that perverted the company's morals, its morale, and its ability to kill badly
conceived deals. It was, one employee stated, "like everything else at
Enron. It started out as a good thing and then it got corrupted." The
PRC gave the company's traders and deal makers a method by which
they could assure themselves of hefty paydays. They could engineer
deals that looked great from a mark-to-market accounting standpoint
but produced no cash revenue.
But, of course, those same employees expected their paychecks to be
paid in cash. And that disconnect between the need for cash and the
mirage of mark-to-market accounting was starting to have an effect. By
the end of 1997, Skilling's first year as COO, Enron's cash position was
wretchedand it was going to get worse.
1997
When it came to strategy and starting businesses, Jeff Skilling was a genius. When it
came to understanding the importance of
cash, he was dumber than a box of hammers.
Cash isand always will beking. Unless a company can generate
cash, it cannot survive. As one accounting expert put it, "cash is to a
business what blood is to the human body." A company that generates
plenty of cash can operate for years without worrying about its ability
to pay its debts and its workers or expand its operations. That's why a
company like Berkshire Hathaway, the conglomerate created by Warren Buffett, has been so successful: Buffett buys companies that generate lots of cash that he then uses to buy other companies. He once said
Berkshire reminded him of "Mickey Mouse as the Sorcerer's Apprentice
in Fantasia. His problem was floods of water. Ours is cash."
Skilling never had anything like a flood of cash. Instead, his entire
tenure was marked by a cash drought.
Rich Kinder understood the value of cash and continually
demanded that his managers meet cash flow targets as well as profit
projections. He understood that Enron could expand only as fast as its
cash flow allowed. And throughout his tenure, he made sure that the
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amount of cash Enron spent on new projects was about equal to the
amount of cash it earned from its operations. That makes perfect sense.
If a company invests more in its operations than it earns, it has to borrow money. Companies can borrow money, but whatever they borrow
must be repaid in cash, and that cash has to come, eventually, from the
company's business or it will fail.
Information about a company's cash position is published on a
quarterly basis in its cash flow statement. The statement divides cash
into three categories. The first category, cash derived from (or used in)
operations, is the most important one. It shows whether a company is
making or losing money on its core business. The second section is the
amount of cash used in investing activities. This includes capital expenditures for new trucks, plants, or other fixed assets. The last section is
the amount of cash the company obtained from financing, that is, how
much money the company borrowed or paid backto finance its
ongoing operations.
Kinder was a tightwad. In his seven years as president of Enron,
Kinder added very little long-term debt to the company's balance sheet.
During that same time period, Enron's profits totaled $z.6 billion. In
1996, Kinder's last year at the company, Enron took in just over $I billion in cash from its operations, and its long-term debt totaled $3.3 billion.
"Kinder made everybody accountable for every penny," said one senior finance person, but "when Skilling came in, there were no budgets."
In 1997, his first year as COO, Skilling nearly doubled capital
expenditures, the expenses companies make to buy more hard assets
like factories and trucks, to $I.4 billion. Enron's long-term debt nearly
doubled, to $6.25 billion. Along with the increased borrowing came
higher interest expenses. In 1997, Enron's interest expenses jumped by
44 percent, from $290 million in 1996 to $420 million. And by 2ooo,
interest expenses would nearly double again, reaching $834 million.
Where was Skilling spending the money? Everywhere.
In 1997, Skilling's gas and power trading group, Enron Capital and
Trade, spent about $2 million on flowers, according to an auditor who
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worked for the division. "Oh yeah, we had secretaries sending their
bosses flowers, bosses sending their secretaries flowers. For a while, we
were the biggest customer for about five florists all over Houston," said
the auditor. "We found out some secretaries were sending flowers to
their friends so the secretaries could get the pretty vases the flowers
came in."
Flowers, first-class airfare, first-class hotels, limousines, new computers, new Palm Pilots, new desksEnron employees began to expect
the best of everything, all the time. And there were salaries, lots of
salaries. When Kinder left Enron at the end of 1996, the company had
7,500 employees. By the end of 1997, it had over 15,000. The pattern
held. By the end of 1999, there were 17,900 employees; by the end of
2.000, 2o,6oo. And every one of them had to be paid in cash.
Every time one of the company's traders booked a big power plant
deal or gas trade, the company used mark-to-market accounting to
book a huge profit for Enron. But all of that "profit" was not cash, and
given the incentives for the trader to inflate the value of a given deal, it
might not ever become cash. Meanwhile, the trader who'd done the
deal got his bonus paid in cash. In addition, the phone, the computer,
the desk, the secretaries, the Internet access, and the paper clipsall of
the expenses that came with the traderhad to be paid with cash. Yet
Skilling told one internal auditor that he did not believe that revenue
generators like his beloved traders should ever have to see their expense
reports. Predictably, that attitude opened the floodgates. "The excess
was obscene. We were just pissing money away." The auditor said that
Skilling "absolutely refused to accept the idea of cost accounting. So he
had no way to measure the profitability of the trading business. No
other Wall Street firm does that. If you don't look at expenses versus
revenues, you can't ever figure out what your profits are."
A senior finance executive at Enron who worked closely with
Skilling said the former McKinsey consultant knew cash flow was a
problem. "But he kept the checkbook open. Skilling thought that you
could always find financial ways to come up with cash, and it didn't
include managing spending and watching your checkbook."
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Jeff Skilling and Ken Lay could not or would not slow down the company's spending spree on big projects both in the United States, and
abroad. In 1997 alone, the company bought Portland General Electric
Company and bought back the shares of a former subsidiary called
Enron Global Power and Pipelines. In all, the company spent more than
$3.8 billion in cash and stock acquiring new assets in 1997. In addition, the company's capital expenditures jumped from $878 million in
1996 to more than $1.4 billion in 1997. Those expenditures included
investments in power plants in Guam, India, Turkey, Puerto Rico, Italy,
Britain, Poland, and Brazil.
All of that spending was showing up in Enron's finances. Around
Halloween in 1997, it appears Skilling began realizing he had to do
something to shore up the company's cash shortage and he had to do it
quickly. If he didn't, his free-spending ways and lack of focus on cash
flow would doom Enron.
NOVEMBER 5, 1997
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the company. All of them were now serving on the company's management and operating committees. In addition, the gas and electric power
trading businesses were thriving, just as Skilling had expected. Pai, a
genius at trading, appeared to be doing well at Enron Energy Services,
the company's new retail power business. The pipelines were ticking
along. It appeared Enron's purchase of Portland General was going to
help Enron solidify its position in the electric power business. Electricity trading volumes were soaring, and new markets were opening. Revenuesthanks largely to the company's use of mark-to-market
accountingwere growing like mad. Enron was on pace to exceed $2.0
billion in revenue for 1997. It would be an increase of more than 50
percent over what Kinder had done in 1996.
But expenses were murderous. Cash flow from operationsthe
amount of real money the company was making from its businesses
had been negative almost from the day Skilling moved up to the fiftieth
floor. In the first quarter, cash flow had been negative to the tune of
$142 million. In the second quarter, the losses had nearly quadrupled to
$52.3 million. By the end of the third quarter on September 30, the cash
flow situation had grown even worse. Enron's negative cash flow from
operations was a whopping $588 million.
Some of the cash problems weren't Skilling's fault. Four and a half
months earlier, the J-Block chickens had come home to roost. The JBlock gas deal, struck in 1993 just after Enron completed the Teesside
deal, had come back to bite Enron with a vengeance. On June 3, a London court put an end to years of legal wrangling between Enron and a
group of North Sea oil companies and ordered Enron to pay the companies a total of $440 million. The ruling forced Enron to take a second quarter restructuring charge write-down of $675 million. That
meant Enron's 1997 profits were going to be lousy.
And there was another problem: The California Public Employees'
Retirement System, CalPERS, wanted to cash out of a joint venture that
it had created with Enron in 1993. The venture, called the Joint Energy
Development Investment Limited Partnership or JEDI, was funded with
$500 millionCalPERS put in $2,50 million in cash; Enron put up 12.
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million shares of its own stock. The partnership invested in natural gas
projects. But in fall 1997, CalPERS informed Enron that it wanted to
sell its stake in JEDI so it could invest in other deals. That sent Skilling
into a tizzy.
With JEDI, Enron had the best of both worlds. As a half owner in
the deal, Enron could record any revenues (or losses) on its income
statement, but it didn't have to show JEDI's debts on its balance sheet.
That was because JEDI's debts really didn't belong to Enron. So Enron
could show good revenue growth while maintaining a better-than-average credit rating. And with Enron's trading business taking off, the
company's credit rating was critically important to Skilling. That's
because when big companies borrow money, the amount of interest
they are charged is usually determined by agencies like Moody's or
Standard 8c Poor's, which rate a given company's ability to pay its
debts. Enron wanted to keep an investment grade rating so its cost of
capital would stay relatively low. Trading businesses need access to
large amounts of low-cost capital. If Enron's credit rating fell below
"junk" level, its ability to continue trading would have been hampered
because its cost of capital would be too high.
Skilling simply had to keep JEDIand the $600 million in debt that
came with itoff Enron's books. So he turned to his financial wizard,
Andy Fastow, who quickly came up with the solution: a new entity
called Chewco, named for the Star Wars character Chewbacca, that
would be owned by another Enron official, Michael Kopper. But to
make it work, they'd have to get the legal work done in a big hurry and
then they'd have to get it approved by the Enron board.
Fastow realized that the easiest way to keep JEDI's debts off Enron's
books was to put them on someone else's books. So he'd have Chewco
simply buy CalPERS's stake in JEDI. The cost to Chewco: $383
millionan amount that would account for all of CalPERS's original
investment and all of its profits from the partnership. Kopper, an upperlevel financial manager at Enron, didn't have $383 million, nor was he
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able to borrow that much money. But Fastow saw a way around the
problem. Under the accounting rules, Chewco could qualify as a partnership that was wholly independent of Enron if it satisfied three simple tests:
At least 3 percent of Chewco's capital came from outside (that is,
non-Enron) investors. That meant that Kopper had to raise at
least $11 million to make Chewco viable.
The entity was not controlled by Enron (dubious, since Kopper
worked for Enron).
Enron was not liable for any loans or other liabilities (the key
issue for Chewco).
Although $11 million wasn't much for Enron, for Michael Kopper
it might as well have been $11 billion. Kopper simply didn't have that
much money. He and his domestic partner, William Dodson, were able
to come up with $12.5,000 in cash. But Fastow apparently had another
idea. He convinced Barclays Bank to lend Chewco $Z4O million, a loan
that was guaranteed by Enron. Then he arranged for JEDI to lend
Chewco $132 million. Then they raised an additional $11.5 million
from two other entities that became general and limited partners in
Chewco. The two entities, called Big River and Little River, were controlled by Kopper, who later transferred part of his interest to Dodson.
Big River and Little River's only real asset was the $125,000 in cash
that Kopper and Dodson raised. The rest, about $11.4 million, was
borrowed from Barclays. But here's the rub: The loan from Barclays to
Big River and Little River was ultimately guaranteed by Enron.1
That guarantee meant three things: Enron hadn't made an arm'slength transaction; it was still liable for the debts of Chewco, and that
meant Kopper hadn't satisfied the 3-percent ownership requirement.
Kopper and Fastow had, wittingly or unwittingly, done a deal that
would be a key part of Enron's undoing.
But the deal didn't slow down. Vinson & Elkins, Enron's longtime
law firm, helped set up the Chewco deal in what might have been a
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143
much of the $588-million cash shortfall and end 1997 with positive
cash flow from operations of $2.11 million.
By mid-February, Enron's stock was beginning a steady upward
move, prompting another analyst, Robert Christenson, from Gerard
Klauer Mattison to tell Bloomberg that Enron was a "growth stock"
that was "finally starting to kick up its heels."2 That was certainly true.
And by Apriljust five months after Skilling, Fastow, and Kopper had
talked the board into approving the Chewco dealEnron's stock had
risen by zi percent.
Jeff Skilling was off to the races and Chewco was forgottenat
least for a while. But the bastard financing that Fastow created in the
Chewco deal was only the beginning. A myriad of new off-the-balancesheet deals were in the offing, deals with names like LJM and Raptor,
that would be increasingly convoluted.
Enron had started down a slippery ethical slope. And no one in
authority seemed to care.
Sexcapades
SEXCAPADES
145
top-level Enron executive. "When I saw that, I said, 'There's no hope for
this company.' It was like a French court under Louis the Fourteenth."
Carterwhose compensation package from Enron in 2.001 included
a salary of $261,809, a bonus of $300,000 and a long-term incentive
bonus of $75,000 (she also got restricted stock grants valued at
$307,301)wasn't the first woman who got to the top on her back.1
"The only women who got ahead at Enron were either very masculine in their nature or were sleeping with somebody," said a (female)
auditor who left Wall Street for a job with Enron in the late 1990s.
Sex and extramarital affairs are not, by themselves, a problem for
companies. But at Enron, the sexual misconduct happened at such high
levels that it became a part of the company's culture. The sex, said one
executive, "set the tone for the rest of the company. And you couldn't
get away from it. It was like a humidifier. It was in the air." The problem, of course, was that the humidifier was located on the fiftieth floor
of Enron's headquarters, and the steam radiated down from there.
The most infamous sexcapade at the company involved one of
Skilling's buddies, Ken Rice, whose long-running extramarital affair
with another Enron employee, Amanda Martin, became something of a
running joke inside the building. "I was shocked when I joined Enron. I
had such good morals," said one human resources manager who
worked at Enron for many years. "And here were these two, Ken and
Amanda, they were wide open about it. They didn't try to hide it at
all." Rice and Martin's public displays of affection in the office provided a bit of R-rated entertainment for their coworkers. Sources said
that Martin, an attorney and longtime Enron employee, would often go
into Rice's office and sit on his lap, or she would sit on his desk in front
of him. Or the two would go to Martin's office, which had glass walls,
and fondle each other, completely oblivious to the impression they were
giving their coworkers.
Rice became so brazen about his infidelities that he bragged about
them to his coworkers. One Enron official who'd gotten married a few
months earlier told a story about riding on one of the Enron jets with
Rice. While coming back from a business trip, Rice turned to his
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coworker and asked, "So, have you cheated on your wife yet?" The
man, surprised, answered that he had not and wasn't planning to. To
which Rice reportedly replied, "Well, why not?"
A Wall Street analyst who covered Enron for years said the sexual
shenanigans at Enron became an important part of his take on the company and its financial statements. The analyst said when someone like
Skilling, who has a wife and three kids and is heading a major company, starts sleeping around, "it addresses the character of the man.
This is a guy who felt he could get away with anything. You saw it in
his personal life and his business life."
Skilling's affair with Carter (the two married in early zooz) was just
a facet of the boys' club at Enron. Several women who worked at
Enron said Skilling and the young traders who dominated the company
viewed women as a commodity that could be bought and sold just like
gas, electricity, or any of the other products Enron was trading. And
since Houston's strip clubs are among the best in the country, it was
only natural that Enron's boy geniuses visited them with regularity.
Joints like Rick's Cabaret, Treasures, and The Men's Club were the
most popular venues. Enron executives like Lou Pai reportedly visited
them regularly. In fact, Pai's passion for strippers began costing Enron
so much money that Ken Lay had to lay down the law. Around 1995,
after Pai reportedly submitted an expense report with huge strip club
expenditures, Lay sent out a famous companywide memo that said
Enron would no longer reimburse expenses from the strip clubs.
But that apparently didn't stop Pai. Numerous sources inside Enron
say that late one night in the mid-1990s, Pai brought a pair of women
of ill-repute to Enron's headquarters. Pai took them upstairs to one of
the conference rooms and allegedly had sex with them on the conference table. (Pai has denied ever taking prostitutes into the building.
Lawyers for Pai's wife, Lanna Pai, refused to comment.)
In addition to the affairs occurring among the company's top managers, lower-level employees were also hooking up for romantic adventures. And in many cases, it made perfect sense: Enron was a hothouse
environment filled with lots of intelligent, driven young people who
SEXCAPADES
147
worked very long hours and therefore had few opportunities to mingle
with members of the opposite sex outside of the workplace. Some of
those liaisons ended in marriage, of which there were several among the
lower and middle tiers at Enron. And the affairs at those company levels were not conducted maliciously. Nor were those workers supposed
to be setting an example for the entire company. Ken Lay, Jeff Skilling,
and their highest-ranking lieutenants were.
One headhunter in Houston who worked for a number of energy
firms (including Enron) said the sexcapades at Enron even affected how
other companies approached hiring. The headhunter remarked that in
the late 19908, he was doing a top-level executive search for Dynegy.
After he met with Dynegy's top managers to clarify the skills the company wanted in the new person, the headhunter was pulled aside by
Dynegy's CEO, Chuck Watson. "I want to tell you something," Watson
confided to the headhunter. "On our executive team, the most important thing is ethics and integrity. All of the executives on this floor are
still married to our first wives. Bring us people who fit our ethics and
integrity."
Although Ken Lay paid lip service to ethics and integrity, he had
been compromised by his own past. As one former top-level Enron
executive said, "Leaders cast shadows." And the shadow that Lay cast
at Enron was that of a man who couldn't, or wouldn't, do anything to
put a stop to the sexual misconduct.
One source close to Lay recalled that several employees complained
directly to him about the oversexed atmosphere at Enron. In at least
three instances, Enron employees wrote Lay and asked him to put a
stop to the Ken Rice-Amanda Martin affair. The source said one letter
"came through the office mail threatening legal action if some steps
were not taken" to deal with the problem. But Lay was reluctant to do
anything about it, according to the source.
So the sexcapades continued. And they became another facet of
Enron's corrupt leadershipone that went hand in hand with the company's corrupt bookkeeping practices. "The marital misconduct created
an atmosphere where things had to be covered up," said one member
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MARCH 1999
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Mark Lay, Ken's son from his marriage with Judie, didn't experience
many disadvantages by being the son of the Enron chairman and CEO.
151
But Enron did. It appears every deal Enron made with the son of the
chairman lost money. Among the most questionable was one involving
Bammel Field.
Located about eight miles west of the passenger terminals at Bush
Intercontinental Airport in northern Harris County, Bammel Field is
one of the wonders of the American natural gas business. The largest
gas reservoir in Texasas well as one of the largest facilities of its kind
on earththe depleted oil and gas field acts like a gigantic storage
locker for power companies and other gas users. Bammel allows gas
utilities and others to assure delivery to their customers even during
times of highest gas demand, like extremely cold or extremely hot
weather. It also allows them to hedge against price risk. Gas prices fluctuate constantly and are often tied to changes in temperature. For
instance, gas consumption usually rises in the winter, and that generally
leads to higher prices for gas. To counter that effect, utilities and other
big gas users buy gas during the summer and inject it into storage for
use during the winter months. Bammel Field is perfectly situated for
that use. The field lies near two major pipelines, one owned by Houston
Pipe Line (a division of Enron) and the other by Williams Companies.
The location provides access to a broad array of industrial companies
that sit near the Houston Ship Channel as well as to the pipelines that
feed gas to the residents of Houston and surrounding cities.
The other key attribute that makes Bammel valuable is its size. Bammel Field can store 117 billion cubic feet of natural gas. That's roughly
equivalent to 19.5 million barrels (800 million gallons) of crude oil.
Bammel alone can hold enough gas to supply America for nearly two
days. Since 1952, Bammel Field has been one of Enron's most prized
assets. It was the kind of asset that Enronand Houston Natural Gas
before itwould never let anyone else have access to. It was simply too
valuable.
That history mattered not a whit when Mark Lay came along. On
April Fool's Day in 1994, Enron cut the sweetest of sweetheart deals
with Lay the Younger, who, according to Enron's proxy statement,
owned one-third of a company called Bruin Interests. Under the terms
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of the deal, Mark Lay's company was given the right to store and
retrieve up to 8 billion cubic feet of gas in Bammel. Bruin paid
$800,000 for that service and agreed to make "certain payments" when
the company withdrew the gas. For reasons not explained in Enron's
proxy statements, Bruin, upon the signing of the contract, almost
immediately flipped its right to store the gas to an unnamed third party
that was unaffiliated with Enron or Bruin. Although it cannot be
proven that Bruin paid less than other companies were paying for gas
storage, it can safely be assumed that Bruin couldn't have made a profit
on the deal without charging the unnamed "third party" more for the
storage than Enron charged Bruin. Nevertheless, Enron's proxy claims
the terms of the storage deal with Bruin "are comparable to those available to unaffiliated third parties."
Piffle. "Nobody but Ken Lay's son or brother-in-law could have made
a deal like that. That's the only time we ever leased out Bammel," said a
former high-ranking Houston Natural Gas official. "It was a bad deal. I
couldn't believe it when I heard about it. Bammel was a crown jewel for
the company. There's no value that Mark Lay could add by being a customer out there except to cut into Enron's potential margins."
Enron had absolutely no reason to allow Bruin to have access to
Bammel. If a company needed gas storage, it could simply buy that
capacity from Enron and bypass a third-party interest like Bruin. Furthermore, it was doubtful that a neophyte in the gas business like Mark
Lay would have had any contacts in the business whom the gray-heads
at Enron didn't already know.
But the deal was done, in part, according to an executive close to
the deal, because Jeff Skilling supported it. "Skilling did it to get close
to Lay," said the source. "Three of us said, 'We aren't doing that deal.'
Ken was naive that it wouldn't come back to haunt him. Most smart
people would have known better." The executive said Ken Lay could
easily have called on his friends in Houston to hire his son instead of
putting him to work at Enron and creating a potential ethics problem.
"If it had been me, I'd have called [former Transco chief] Jack Bowen
up and said, 'Give him a job.'"
153
Bammel Field was just the first of a string of deals that Lay did to
keep his son in cornflakes. In January 1996, Enron got into another
quirky deal with Mark Lay to study "the fixed price purchase and sale
of certain paper products." Enron put up $300,000 for the paper
study. It appears that Lay the Younger and his partner in the deal,
United Media Corporation (a company for whom Lay had done consulting work), put up no serious money. Four months later, that deal
was canceled.
But that same year, Enron hired Mark Lay and his friends at Bruin
to study an entirely different business: iron carbide, a potential substitute for the scrap metal needed in making steel. Enron agreed to pay
Bruin a $2,5OO-per-month retainer and gave Bruin several incentives,
including a $100,000 bonus payment if it made any iron carbide deals.
By March 1997, Enron had paid Bruin $33,500 under the terms of the
consulting agreement, and two months later, the company decided
Mark Lay was so irresistible that the company hired him full-time to
work on the development of "a clearinghouse for the purchase and sale
of finished paper products."
As part of that deal, Enron agreed to pay off slightly more than $i
million in debts accumulated by Lay the Younger and a group of other
people who were former owners of a company called Paper and Print
Management Corporation. In addition to the loan forgiveness, Mark
Lay got a three-year employment contract with Enron that made him a
vice president, gave him a $100,000 signing bonus, a guaranteed minimum annual bonus of $100,000 for 1997, 1998, and 1999, and
options to purchase 2.0,000 shares of Enron common stock.
Once inside Enron, Mark Lay became knownnot surprisinglyas
one of the untouchables. He not only had the backing of Skilling for all
of his pie-in-the-sky deals, but he was the son of the chairman and
CEO. "Whenever we were in the PRC [Performance Review Committee] meetings, we always had to rank Mark Lay," said one source.
"And it always created this really awkward situation. His name would
come up, and no one would say anything. He wasn't the sharpest tool
in the shed."
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LJM1
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LjM1
157
At least 3 percent of the equity had to come from outside (that is,
non-Enron) investors.
The entity could not be controlled by Enron.
Enron was not liable for any loans or other liabilities.
LJM1 might have qualified under two of the three. But how was
Enron going to be able to prove that the special-purpose entity wasn't
controlled by Enron when the company's CFO was managing all of the
investments? It appears that neither Lay nor Skilling thought about it.
Nor did Lay consider how much money Fastow might make on the
assets he was buying from Enron.2 After a bit more discussion, Lay
agreed to bring Fastow's proposal to the Enron Board of Directors at
the board meeting on June 28, 1999.
At that board meeting, after a short debate, the company's Board of
Directors agreed to waive Enron's ethics policy, which prohibited the
company's officers from doing deals directly with the company, and
approved the LJM1 deal. The approval opened the floodgates. And
LJM1 became the cornerstone of Andy Fastow's financial house of cards.
One of those deals included LJMI's September 1999 investment of
$15 million in Osprey. Although it's not clear why LJMI invested in
Osprey, the new entity flipped that investment to Chewco, Michael
Kopper's company, just three months later.
During the same month that LJM1 bought part of Osprey, it also
purchased a 13-percent stake in Enron's Cuiaba power plant in Brazil,
even thought the plant wasn't yet operating. In fact, the power plant
was stuck in the midst of an international brouhaha over Enron's plan
to push a gas pipeline through a rare dry tropical forest. One of Enron's
financial backers, the U.S.-taxpayer-backed Overseas Private Investment Corporation, reluctantly agreed to provide millions of dollars in
loans on the project after long negotiations. Cost overruns and environmental problems were causing Enron a world of headaches.
Despite the problems, LJM1 paid Enron $11.3 million for the interest in the plant, a move that allowed Enron to change its accounting
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LJM1
1S9
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OCTOBER 11,1999
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count on having one of Enron's fleet of corporate jets pick them up and
deliver them directly to the meeting. It was a great time-saver for the
board members, who also avoided the hassle of having to deal with airports and the possibilities of lost baggage or missed flights.
The company's meetings were always held in posh locations. The
previous week, the Finance Committee had met at the ultra-plush resort
The Breakers, in Palm Beach, Florida. Other times, there would be
meetings in London or Colorado, and the board members always
stayed in the best hotels. And the pay was great. Each of the independent directors was getting $50,000 a year for sitting on the Enron board.
In addition, they got another $1,2.50 for each meeting they attended.
On average, each of the independent directors was getting nearly
$87,000 a year in cash and stock options from Enron for about two
weeks' workand there was no heavy lifting.
When the members finally settled down and took their seats, they
began dealing with a rather lengthy agenda. The first few matters
involved assuring that Enron was ready to deal with any hazards associated with the YzK problem and selecting members for various committees. An investor relations flack presented figures to the board that
showed Enron's stock soaring, up 4 5 percent for the first nine months
of the year, vastly outperforming the S&P 500, which had returned a
bit more than 5 percent. The board dealt with a few other things such
as compensation and stock sales before turning to a matter involving an
entity called LJM2.
Four months earlier, the board had approved the transactions involving LJMI, which was controlled by Fastow. That deal had required the
board to waive the company's ethics policy. Now, with LJM2, the board
was being asked for another, more far-reaching waiver. Enron's Board of
Directors was being asked to approve what was essentially an openended transaction machine with which Fastow's newly formed company
could do multiple transactions with Enron. And Fastow wouldn't need
the board's approval on each deal. As with LJMI, Fastow would be the
general partner of LJM2. But whereas LJMI had only raised a few tens
of millions of dollars, LJM2 would raise $zoo million or more from a
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It was an important point. Causey may or may not have known, but
Andersen personnel had objected to Fastow's plan. Benjamin Neuhausen, a member of Andersen's professional standards group, which
specialized in tricky accounting issues, raised questions about LJM1 in
May 1999. In an e-mail to Andersen's lead partner on the Enron
account, David Duncan, he said, "Setting aside the accounting, idea of
a venture entity managed by CFO is terrible from a business point of
view.... Conflicts of interest galore. Why would any director in his or
her right mind ever approve such a scheme?" On June i, 1999, Duncan
responded, saying, "On your point i (i.e., the whole thing is a bad
idea) I really couldn't agree more." Duncan told Neuhausen that
Andersen would agree to the LJM deal only if the Enron board and
Ken Lay approved the transaction. And he added, "Andy is convinced
that this is such a win-win that everyone will buy in."
It appears the Enron board wasn't made aware of Andersen's objections to Fastow's conflict of interest. And after presenting all the facts,
Winokur made a motion that the resolution be adopted by the entire
board. His motion was seconded by his fellow board member John
Urquhart. Although Winokur and Urquhart may have been concerned
about Fastow's potential conflicts, they had their own conflicts of
interest.
Winokur was affiliated with National Tank Company, a privately
owned company that provided Enron with oil field equipment and services. Between 1997 and 1999, the company had sold Enron more than
$z.i million worth of goods and services. But even though Winokur's
deal was curious, it did not put money directly into his pocket.
By way of explanation, corporate governance experts frown on
companies that have outside business dealings with their board members. The potential for serious conflicts of interest are too great. Directors who have consulting or other business deals with the companies
they direct may be less willing to object to certain corporate practices
for fear that they might lose their sinecures.
Urquhart's deal with Enron was ludicrously lucrative. In addition to
165
the $87,000 or so per year that he was getting for sitting on the board,
Enron paid Urquhart to be a "senior adviser to the chairman" on such
things as the "implementation of an integrated strategic international
business plan and other matters." Urquhart's consulting deal started in
1991, the year after he joined the company's board, and continued
through the 19905. Lay may have believed that Urquhart's experience in
the power generation businessUrquhart spent forty years at General
Electricwould be valuable to the Enron board. So in 1991, Enron paid
Urquhart $257,500 in consulting fees. In 1992, that figure jumped to
$580,168. In 1993, Enron paid him $562,500. In 1994, he made
$596,354 for consulting and pocketed another $931,000 after exercising options on 56,000 shares of stock. In 1995, he got $592,989 "for
services rendered and another $575,000 by exercising Enron stock
options." And so on: 1996, $625,126; 1997, $632,156; 1998,
$410,106; 1999, $531,710. According to Enron's 1999 proxy, the terms
of Enron's deal with Urquhart included a retainer of $33,075 a month
for providing up to ninety days of consulting services to the company
per year. Any days over that amount were paid at a rate of $4,410 per
day. For an eight-hour day, that amounts to $551.25 per hour.
But wait, there's more. In addition to the cash and stock options,
Enron paid Urquhart an additional $1.16 million (in cash) in the mid1990s in exchange for his agreement to surrender the "phantom
equity" Urquhart had been granted in Enron's international electric
power business. Urquhart kept an office on the fiftieth floor in the
Enron building, although sources who worked on that floor said he
rarely used the office. In all, it appears Enron paid Urquhart about $7.4
million during the 19908 for his expertise. But several high-level Enron
employees said Urquhart wasn't worth it. After Enron finished the
Teesside power plant in Britain in 1993, "the company outgrew the
need for people like him," said one source who worked in the company's international power business. "After Teesside, we had people
inside the company with far more experience than he had."
But Urquhart wasn't the only board member pigging out at the
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167
Belco paid $149 million in cash and assumed $175 million in debt to
take Coda off Enron's hands.
Joe Foy, a board member who'd been with Enron and its predecessor, Houston Natural Gas, since the beginning of time, also had a conflict. He was a retired partner in the Houston law firm Bracewell &t
Patterson, which did legal work for Enron.
Then there was Lord John Wakeham, leader of the British House of
Lords and chairman of Britain's Press Complaints Commission. In mid1999, Wakeham rebuked a cheeky London newspaper, the Sun, for daring to publish a photo of Prince Edward's fiancee, Sophie Rhys-Jones,
who had somehow misplaced her shirt. Although Wakeham was a busy
man in London, his position on the Enron board was not a coincidence.
It was Wakeham who, while serving as Britain's secretary of state for
energy, had granted final approval to Enron's massive Teesside cogeneration power project in 1990. And now Enron was paying him back.
Beginning in 1996, Enron, in addition to paying Wakeham his hefty
director's check, had the British Big Shot on the regular payroll. Wakeham was paid $6,000 per month for "advice and counsel on matters
relating specifically to European business and operations."
Wakeham was supposed to lend more than just advice to the Enron
board. He was also a member of the company's Audit Committee and
was therefore charged with overseeing the company's financial documents. It was a natural position for Wakeham, a chartered accountant
(Britain's equivalent of a certified public accountant) with extensive
experience in private practice. Although he was qualified to question
some of Enron's accounting practices, it appears Lord Wakeham was
too busy cashing his checks to pay much attention. One high-ranking
Enron employee who worked in the firm's London office for several
years said Wakeham did a few things to help Enron in Europe shortly
after he joined the board. "But he never earned his keep after that."
In addition to the deals that Winokur, Urquhart, Gramm, Mendelsohn, LeMaistre, Belfer, Foy, and Wakeham had with Enron, three
other members of the board who voted on the LJM2. deal were employees of the company. To a casual observer, it appeared Enron's Board of
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Water conferences are usually boring affairs. Filled with too many middle-aged men whose fashion sense favors the timeless pocket-protectorand-a-tweed-jacket look, the conferences attract few interesting
personalities and even fewer women. But the water wonks who went to
New York City in mid-1999 knew to expect something different. Not
only would the meeting be held at the World Trade Center, but Rebecca
Mark was going to give a speech.
Most of the attendees had never seen Mark. But they had heard of
her and they knew enough to expect a show. They weren't disappointed.
According to conference attendees, Mark arrived, as was her custom, via limousine. And although the weather in New York was warm
at the time, Mark swept into the meeting room wearing a dark floorlength fur. "It looked like it cost a ton of money. I don't know what
kind it was, maybe Russian sable. It was gorgeous," said one attendee.
As she walked to the front of the meeting room, she was trailed by an
aide, a matronly, decidedly unfashionable woman, who appeared to be
in her late fifties or early sixties. Mark bore straight ahead, looking neither right nor left. Her strutting manner made it clear that she was
going to show these tweedy know-nothings that Enron was in the water
business to stay. Soon, the utility geeks would know that her new com-
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Enron would have never allowed Rebecca Mark to attack the world
water business had she not brought Dabhol back from the dead.
Mark was successful in pushing through Phase One of the project.
But in 1996, Dabhol was stopped before it ever generated a dime's
worth of power when India's longtime ruling Congress Party was
tossed out of office and the government's agreement with Enron on
171
Dabhol was tossed out, too. Mark worked tirelessly to revive Dabhol.
For months, she shuttled back and forth between Houston and India,
negotiating and cajoling a platoon of Indian officials. The Indians
finally agreed to reinstate the contract after Enron reduced the cost of
the project and offered a slightly better power purchase deal. But
Mark's problems continued. Local protesters cut off the water supply
to the construction site. Human Rights Watch and Amnesty International both documented serious cases of human rights violations at the
Dabhol project site. The abuses carried out by local police including
beatings, arbitrary arrests, and threats against local people who were
protesting against the project.1 Human Rights Watch alleged that
Enron and the other owners of the project "benefited directly from an
official policy of suppressing dissent through misuse of the law, harassment of anti-Enron protest leaders, and prominent environmental
activists and police practices ranging from arbitrary to brutal."2 Opponents filed more than two dozen lawsuits in an effort to stop the project. Enron won them all. But during the lengthy haggling process, the
project kept growing in size and cost. Local politicians got new roads,
schools, and other projects rolled into Dabhol.
Mark was getting plenty of help from the Clinton administration on
the project. Clinton's chief of staff, Thomas F. "Mack" McLarty,
pushed hard for Enron's position. So did Clinton's energy secretary,
Hazel O'Leary. Enron made sure to compensate the people who helped
the project in India. About the same time Mark was pushing to revive
the project, Enron hired the just-retired U.S. ambassador to India,
Frank Wisner. Enron installed Wisner on the Board of Directors of its
subsidiary, Enron Oil and Gas, which had a number of projects in
India. Given his expertise, it's no surprise the company appointed Wisner to chair its "International Strategy Committee."
The assistance from the Clinton administration, combined with
Mark's doggedness, convinced the Indians to approve the construction
of Phase Two of the project, which added another 1,444 megawatts of
power and a $i-billion liquefied natural gas (LNG) facility. What had
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been a billion-dollar project during Phase One would now be a $2.9billion project.
Mark's ability to push through the second part of Dabhol before the
first phase was even completed amazed many Enron employees who
were working on Dabhol. They believed the company needed to let the
naphtha-fired Phase One get up and runningand more important,
show it was profitablebefore they built the LNG terminal. But Mark
prevailed. She got a bigger project. And a bigger project meant no
surprise a bigger bonus. Getting the second phase of Dabhol
approved right away "meant doubling or tripling her bonus," said one
Enron employee who worked on Dabhol. "I'll never again underestimate the power of an incentive compensation program and the desire it
can instill in people."
The Dabhol project made Mark one of the most famous women in
India. It also did wonders for her ego. Unfortunately, no one was willingor ableto harness her ambition. "I enjoy being a world-class
problem solver," she said in 1996. "I'm constantly asking, 'How far can
I go? How much can I do?'"3 That kind of ambition was obvious to one
executive who worked closely with her. Mark "wanted to eclipse [John]
Wing. Ultimately, she wanted to eclipse Kinder, Skilling, and even Lay."
By 1997, her division's backlog of international projects totaled
some $zo billion. In 1998, Forbes reported that Enron International
had revenues of $1.1 billion and reportedly contributed about 17 percent of Enron's operating profits.4 But about that same time, Enron quit
breaking out its international revenues, a move that prevented outsiders
from seeing whether the company's international ventures ever made
any real money.
Profitable or not for Enron, Mark did very well. Company proxies
show that between 1996 and 1998, her total compensation was $25.7
millionthat's more than any other Enron employee during that time,
including Ken Lay ($16.7 million) and Jeff Skilling ($25.4 million). By
1998, she was named vice chairman of the Enron board and held voting power on more stock than anyone else on the board except Robert
Wells like this 1906 gusher at Spindletop helped spawn the creation of dozens of oil and pipeline
companies including Houston Natural Gas, which became Enron. (The Granger Collection)
Pipelines like this one being constructed in East Texas during the late 1960s or early
1970s, helped Houston Natural Gas become one of Houston's most profitable companies.
In 1993, Enron CEO Ken Lay was standing tall. (Getty Images)
Rebecca Mark thinks Big Thoughts while aboard a plush Enron jet.
Although her failed water and power projects cost Enron $2 billion, she
flew away with $100 million. ( 2002 Michael J.N. Bowles)
Jeff Skilling, the ruthless McKinsey & Co. consultant who became Enron's president,
and later, its CEO, never doubted his own genius. After a speech to a group of analysts,
Skilling said they "didn't get it. I was brilliant." (Paul Hosefors//Vew York Times)
Enron CEO Ken Lay awards a silver platter to George H. W. Bush as sons George W.
and Jeb look on. The platter matches their silver spoons. (Houston Chronicle)
Wendy Gramm and her husband, U.S. Senator Phil Gramm, were acquired by Enron
in 1993 in a cash and stock deal worth
tens of thousands of dollars. Enron's
equity interest in the couple is now worthless. (Paul Hosefors/NewYork Times)
Linda Lay, wife of Ken Lay, cries that she and her disgraced husband
have "nothing left" while appearing on the Todayshow on January 28
and 29,2002. (Reuters)
The Lays' version of "nothing" includes their homestead, which occupies the entire 33rd floor
of this swank River Oaks high-rise. Their 12,827 square-foot abode was recently appraised at
$7.8 million.
Located near the intersection of Avarice Avenue and Gluttony Drive, Linda
Lay's new boutique in Houston, Jus' Stuff, is the place to shop for antiques
and other gewgaws once owned by the rich and infamous.
173
Belfer, Ken Lay, and Jeff Skilling. Despite her wealth of assets, Enron
began treating Mark like a favored Third World country. In 1998,
Enron forgave all of the principal and interest on a $955,343 loan the
company had granted her in 1997. In early 1999, the company allowed
even more debt forgiveness, pardoning an additional $700,000 loan the
company made to her in 1998.
She also spent plenty of the company's money. While traveling, she
insisted on limousines and the finest hotels. And she was apparently
allergic to commercial airlines. According to Enron's proxies, her personal use of the company's jets cost over $141,000 for 1997 and 1998
alone. One estimate put her air travel at 300,000 miles per year, meaning the cost of keeping Mark aloft in Enron's jets for business travel
likely cost millions of dollars per year. Personnel at Enron International
dreaded Mark's visits, not because she would see anything they didn't
want her to see but because, as one executive said, "whenever her jet
touched down, we knew it was going to cost our project $60,000."
In addition to the salary, loans, and perks, Mark earned big cash
bonuses on many of Enron's international projects. Her 1998 employment agreement with the company shows she was paid more than $3
million for two relatively small overseas projects. And she apparently
made an enormous amount of money on the Dabhol project. Lead project developers in Enron's international business were paid between 3
and 4 percent of the net present value of a project when they closed the
deal. When Mark pushed through Phase Two of the Dabhol project,
the energy facility was given a net present value of $1 billion, according
to one source close to the project. That means Mark likely split a bonus
of $30 to $40 million with one or two other people.
Of course, with all her newfound wealth, Mark couldn't live in just
any Houston neighborhood. She was a Big Shot and she belonged in
River Oaks. So in September 1998, she bought a beautiful $2.-million
property complete with 2.3 acres of land and a big red brick home, in
an area of River Oaks known as Tall Timbers. It wasn't quite up to
style, though, so Mark had the house completely remodeled in 1999.
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The remodeling left her with a 10,286-square-foot home with five bedrooms, six bathrooms, two half bathrooms, and a swimming pool. Not
bad for a girl who started on a rural farm.
Later in 1999, to celebrate the financing for Phase Two of Dabhol,
Enron held the party to end all parties for Mark and her team. Numerous politicians from India were flown to Houston. There was a sitdown dinner. The entertainment was provided by Cirque de Soleil.
Every attendee was given a small piece of fancy crystal. It was an
impressive event. And true to Rebecca Mark's style, no expense was
spared. That same attitude would prevail at Azurix.
Enron's Waterworld
NOVEMBER 1999
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ENRON'S WATERWORLD
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Rebecca Mark needed to prove that she meant business. She needed a
big acquisition, and she needed it in a hurry. And by mid-199 8, she
became convinced that Wessex Water was the perfect choice. Wessex
was among the most profitable water utilities in the United Kingdom. It
provided water or wastewater service to about 1.5 million people in
southwestern England, principally in the counties of Avon, Dorset, and
Somerset, as well as in parts of Devon, Gloucestershire, Hampshire,
and Wiltshire.
Colin Skellett, Wessex's CEO, vividly remembered the first meeting
he had with Rebecca Mark and the late Cliff Baxter (a high-ranking
Enron executive who specialized in mergers and acquisitions and who
committed suicide in January 21002,). The June 1998 meeting was held
in Bath, a former Edwardian-era spa town and present-day dormitory
for London's business elite in southwestern England, where Wessex has
its headquarters. Mark, who was fond of expensive hotels, liked the
Royal Crescent Hotel, known for its expensive lodging and Georgian
architecture. Mark and Baxter told Skellett, the Wessex CEO, that they
wanted to keep their negotiations quiet. But Mark apparently couldn't
quite manage to restrain her love of the high life. "This large black
stretch limousine turned up outside the Royal Crescent," recalled Skellett. "It was Rebecca with her short skirt and long legs. If you want to
arrive discreetly in Bath, having a blond in a short skirt in a long limousine is not the way to do it. She made quite a splash when she arrived."
Mark and Baxter told Skellett and Wessex chairman Nicholas Hood
that Enron was in a hurry to get into the water business and wanted to
buy Wessex as quickly as possible. As Skellett remembered, Mark
ENRON'S WATERWORLD
179
offered to buy Wessex for about $10.30 per share, a 30-percent premium over the $8 the company's shares were fetching at the time. Skellett was convinced that a deal was possible. But he and Hood needed a
few days to sort out the proposal and discuss it with Wessex's board.
They arranged to meet a few days later, again at the Royal Crescent.
Skellett and Hood were a bit late for the meeting. And according to
Skellett, Baxter went out in front of the hotel to smoke a cigarette.
While there, the hotel's doorman reportedly asked Baxter, "So are you
the guy who's here to buy Wessex?" Baxter, said Skellett, was stunned.
"After that they became paranoid about security," Skellett recalled with
a chuckle.
Despite the breach of security, the two sides sealed the deal, and on
July 2.4, 1998, they announced that Enron would buy Wessex in a deal
worth $2.88 billion. Not only would Enron's new water business
(which was christened Azurix shortly after the Wessex purchase) get a
big utility, it would get a group of well-trained personnel with technical
expertise in the water business whom Azurix could deploy elsewhere.
The water business is "a logical extension of Enron's expertise developed in the worldwide energy business," crowed Ken Lay in a press
release sent out the day the deal was announced. Wessex's operations
combined with Enron's "expertise in energy infrastructure project
development, asset management, regulatory, finance and risk management services, will enable the new company to become a strong competitor in the global water industry," he predicted.
On the surface, it wasn't a bad idea. Enron had been a pioneer in
both the gas trading business and the electricity trading business. And it
figured it could do the same with Azurix in the water business. "I don't
know how many times I heard that water was going to be 'just like gas
and power,'" recalled a young MBA who was among the first people
hired at Azurix. "But it was a lot."
Rebecca Mark desperately wanted to apply her deal-making skills to
other sectors and believed water was the next logical step. And she had
several reasons to believe it. First and foremost, the water treatment
business is energy intensive. Water engineers point out that about one-
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third of the cost of moving and treating water is energy related. Enron
viewed itself as the king of the energy business, and therefore, it could
get a twofer in the water business. Enron could not only provide the
power and the energy risk management tools a given water utility
might need, it could also run that utility itself, thereby increasing its
potential profits.
Furthermore, Enron saw the global water business as a regulated
business that was going to be deregulated and operated by private companies (again, a parallel to gas and power). When that deregulation
occurred in countries around the world, Enron wanted to be there, with
assets on the ground. Once it owned a big asset such as Wessex or a
water utility in another country, it could use its risk management and
trading skills to make money by selling water to water-short regions
and buying it from water-rich areas. It might also be able to profit by
selling lower-cost power from an Enron power plant to the water utility. To do that, it would buy water utilities in target countries. The business plan, known as a "roll-up" strategy, had worked in such other
sectors as trash and funeral homes. It would surely work in water. The
idea was simple: The buyer would acquire a lot of small mom-and-pop
companies and then use their cash flow to pay off the debt needed to
buy them in the first place. In the process, the buyer would gain
economies of scale.
Enron estimated the value of the worldwide water market at over
$300 billion. Although Suez and Vivendi were the dominant players,
Mark convinced Ken Lay that Enron could capture water contracts in
Europe, Latin America, and Asia that would complement their existing
energy businesses in those regions. And because they were Enron, there
was no way they could be wrong. Or was there?
The world's water utilities have few interconnection points, a fact that
makes moving and trading water very difficult. In the gas business,
pipelines intersect in numerous locations. In the electricity business,
large utilities may not share generating plants but their power lines
often have overlapping service territories. That means that utilities can
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essence, her divorce settlement with Skilling: She'd get her own publicly
traded company. And she'd get it as soon as was humanly possible.
The early 1999 decision to accelerate the initial public offering
astounded some of the early hires at Azurix. They couldn't understand
why the company, which was still developing its business plan, would
go public so quickly. "By the time you distilled it down, it was clear
that the business we were in was the IPO business, not the water business. They'd picked the water business. But the business, really, was to
have an IPO so they could take advantage of the equity market,"
explained one executive who was hired in late 1998.
The equity markets were booming. In 1998 alone, American companies raised $36.8 billion from initial public offerings. Of that amount,
more than $2.7 billion was raised in IPOs conducted for nearly four
dozen Internet companies. Azurix's idea to take on the world water
business was certainly as good as dogfood.com or any of the myriad
other digital Ponzi schemes that were attracting millions of dollars of
new funding. So they decided to set their IPO for June 9, 1999.
Despite the fertile ground for IPOs, the folks at Azurix probably
should have paid attention to the problems plaguing another Houston
company that had launched massive roll-ups of smaller companies. In
January 1999, Service Corporation International, the world's largest
funeral home company, announced it wouldn't meet Wall Street's profit
projections. Although the company blamed falling death rates, it
appeared that the funeral giant, headed by its rapacious founder,
Robert Waltrip, had grown too fast and had acquired far too much
debt to remain profitable. The company's stock got crushed by the
news, falling by more than 40 percent in one day.
Mark wasn't watching other companies. She and her acolytes were
in a hurry. And within a few days of going public, Mark's stock options
in Azurix were worth about $50 million.
But as any good cook knows, haste makes waste. In the case of
Azurix, it led to a decision that arguably sealed the company's fate
almost before it was born. The Wessex acquisition had been costly.
Enron had bought the company at the absolute top of the market.
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However, there was plenty of cash flow, so Wessex could pay for itself.
That wouldn't be true for the Buenos Aires deal.
Alberto Gude's first instructions to his new charges were simple: "Don't
tell anyone you are British."
Gude, who was vice president of information technology at Enron,
wasn't being silly. He was being prudent. It was summer 1999 and he
already had plenty of other problems. Gude had recently flown from
Houston to Buenos Aires so he could help Azurix set up its computer
systems and sort through the mess of electronic records Azurix had
inherited from the previous operator of the city's utility.
It didn't matter to him that the chaps from Britain were just regular
engineers from Wessex Water. It didn't matter that they were going to
help Azurix run the water utility. Local history mattered. And by luck
or by fate, when the British lads arrived, it was nearly seventeen years
to the day since British warships and infantry had routed Argentine
forces in a series of land and sea battles over a small set of islands
called the Falklands, or Las Malvinas, to the Argentinians. Gude, a
practical man who was born in Cuba, knew that the Argentinians were
still mad about the Falklands War and, furthermore, having a British
passport was not going to win friends and influence pretty girls in the
pubs of Buenos Aires.
Sending British water wonks to Argentina isn't the same as sending
coal to Newcastle, but it was just about as sensible. However, Azurix's
management had no other options. Wessex was their cornerstone, their
multibillion-dollar red carpet into the water business. And all of Wessex's employees were, therefore, needed. So as soon as Azurix won the
bid for the entity known as AGOSBA, short for Administracion General de Obras Sanitarias Buenos Aires, calls were made to Wessex's
headquarters in Bath, looking for people able to go to Argentina in
short order. It was, by all accounts, a disaster from the get-go.
"They sent the guys from Wessexnone of whom spoke Spanish
all the way from England. Plus, there was the whole lack of cultural
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ENRON'S WATERWORLD
185
didn't give Azurix the utility's offices. Instead, their new storefront was
several blocks away from the old office. That meant that all of Azurix's
new customers who were accustomed to paying their water bill in cash
wouldn't know where to go. Azurix officials had to be creative. And
after some thinking, they came up with the only feasible solution: Hire
some pretty young women.
There was no way the company's clerks could handle all of the customers that would be coming by the old office to pay their bills. They
needed a group of people to redirect the old customerswith their payments in handto the new office. So the company hired a bevy of
young women. On that first billing day, the young women stood outside the old utility building and directed customers to the new Azurix
office, where cashiers took the money (as well as the names and
addresses) of all the people who came in to pay their bills.
It was an unconventional solution to a sticky business problem. But
it worked pretty well. And the newly imported water engineers from
Wessex Water were more than a little impressed. "They came from a
very staid, regulated British utility business and now they're in South
America, they've got good-looking girls in tight shirts and tight skirts
with the Azurix logo on their shirts, and they're snuggling up to the
customers," one Azurix veteran said, laughing. "It was hilarious."
If the Buenos Aires debacle wasn't going to kill Azurix, Rebecca Mark's
free-spending ways were.
"Azurix operated as if it were a Fortune 500 company from the
beginning," said Skellett, the CEO of Wessex. "The water business is
pretty much a nickel-and-dime business. Your whole focus is on driving
out every bit of cost. To them expenses didn't seem to matter. In the first
year, we were bemused. We thought they knew what they were doing."
Ah, but that's just it. All graduates of the Harvard Business School
act like they know what they're doing. They went to Harvard, didn't
they? But when it came to managing cash and cash flow, Rebecca Mark
was just as clueless as her fellow Harvard Business School graduate
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Jeff Skilling. Like Skilling, Mark spent cash as though she owned a currency printer. Several sources at Azurix said she spent tens of thousands
of dollars decorating her office with expensive rugs, imported drapes,
and artwork. And though some executives argued that her posh office
was justifiable, no one agreed with her decision to build the "stairway
to heaven."
By mid-1999, Azurix was growing at a rapid clip. New people were
being hired to perform various tasksno one was exactly sure what,
but they were important, weren't they?and they had to have desks
and offices. Before long, the tenth floor at 3 Allen Center where Azurix
was headquartered was too small for the young company. The building
manager agreed to let Azurix take over the ninth floor, and people were
already moving down there. But darn it, what if people working on the
tenth floor needed to see some of the people who were working on
nine? They couldn't be sending people down the stairwells or on the
elevator, could they?
Something had to be done. So Mark decided that the company
should have its own stairway connecting the ninth and tenth floors.
Architects were consulted. Engineers engineered. And soon, the stairway, a beautiful, curved stairway with glass panels under the banisters,
was under construction. Never mind that it took months to build or
that insiders say it cost a reported $i million. Many workers at Azurix
were stunned. "I could have used that $i million to buy another company," said one high-ranking executive.
There were other big hits to Azurix's cash flow. The company spent
$5.5 million building a swank new office in London, a few blocks from
Big Ben. Azurix signed a fifteen-year lease on the 23,000-square-foot
office that was going to cost the firm 83,000 a month. "It was meant
to be the European headquarters for Azurix, so it was definitely top-ofthe-line space," commented a source who managed the company's facilities. Azurix never moved in.
Azurix also planned to spend tens of millions of dollars buying
Synagro Technologies, a Houston company that processes sewage
sludge. Synagro was going to be an integral part of Azurix's growth
ENRON'S WATERWORLD
187
plan. But in late October 1999, Azurix suddenly called the deal off,
apparently after company officials realized they couldn't afford to buy
Synagro. That story played out with Enron later paying Synagro $6
million to settle lawsuits related to Azurix's actions.
The company took another big hit in November 1999, when Britain's
director general of water services announced a i z-percent rate cut for all
of Azurix's customers in southern England. The rate cut had been
rumored for a long time. And several water industry officials said Azurix
should have known the move was coming. Prepared or not, it was
another major blow. The company's cornerstone, the utility that was
supposed to throw off lots of cash to fund expansions into other areas,
was hamstrung. Azurix insiders were stunned. "It couldn't have been
predicted," said one Azurix veteran. "The stars lined up against us."
Despite the constant drain on Azurix's cash reserves, Mark didn't
spare expenses when it came to her salary. Azurix paid Mark $710,000
a year to head a company that was losing money hand over fist. In
addition to her salary, the company made sure that Mark didn't have to
fly with commoners during her free time. In 1999 alone, the company
gave Mark an additional $101,146 to cover her personal use of the
company's aircraft.
Amanda MartinKen Rice's girlfriendwas also well paid. Rumor
had it that Ken Lay moved Martin to Azurix, in part to get her away
from her married boyfriend, Rice. Whatever the reason, Martin became
Azurix's executive director and president of North America. Her salary
for 1999: $400,000. But her future was not compromised when Azurix
folded. She went back to a cushy job at Enron Corp., where she made
still more money. In 2.001, Martin's cash compensation from Enron
totaled $8.4 million, which included a salary of $349,487, a long-term
incentive bonus of $5.1 million and $2.8 million in "other" payments.
Martin also received another $2 million by exercising her stock
options.2
Azurix even spent huge amounts of money to get rid of executives.
Shortly after her shouting match with Skilling in the tenth-floor conference room at Azurix's office, the Azurix Board of Directors gave Mark
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ENRON'S WATERWORLD
189
shares, a move that brought her total stock-sale proceeds to $82.5 million. Counting all the salary, stock options, and no-payback loans that
she got from Enron, Mark probably banked somewhere in the neighborhood of $100 million. That's a truly staggering sum when you consider that her misguided deals in India, Argentina, and elsewhere cost
investors at least $2 billion.
But those failures were in the past. None of them mattered. She was
rich, gorgeous, and married again. Her new husband was Michael Jusbasche, a rich Bolivian-born businessman. The two were moving into
her house in River Oaks and would continue supporting a few local
causes. The failure of Azurix was no longer a concern. In early 2002,
Mark told Vanity Fair that the company "wasn't a disaster. We couldn't
survive as a public company because we didn't have earnings sufficient
to support the growth of the stock."3
Oh.
So Azurix wasn't a disaster. It just didn't have "earnings sufficient to
support the growth of the stock." That's a beautifully crafted phrase to
describe a dog of a company that should never have gone public in the
first place. In the end, Mark's vision the commoditization of water,
water trading, yet more fawning profiles of her in the business press
landed with a stinging belly flop. And Azurix, the company that was to
"become a major global water company" lasted as a publicly traded
entity for just twenty-one months.4
The bath Enron took on Azurix would prove very costly. Mark's
debacle had been financed withwhat else? off-the-balance-sheet
entities, so that Enron didn't have to reflect Azurix's debts on its balance sheet. And those interlinked entities, called Marlin and Osprey,
would play a pivotal role in drowning Enron. There's no doubt the
Azurix mess was poorly thought out, but Rebecca Mark and her team
weren't really corrupt. Misguided maybe. They made some bad judgments and didn't pay attention to expenses. Perhaps their idea was just
ahead of its time. But they never purposely misled investors or committed fraud. That would not be the case at another overhyped Enron venture, Enron Broadband Services.
Stock analysts and professional money managers have an unspoken etiquette: During
meetings with companies, you should always
leave the meeting room when using your cell
phone to give buy or sell orders. It's a simple rule, born out of a desire
to show respect for the company and for fellow analysts. No one wants
to listen to someone else's transactions while trying to follow the points
of a speaker on the podium.
But at Enron's January 20, 2000, meeting with Wall Street analysts
at the Four Seasons Hotel in downtown Houston, that etiquette was
routinely ignored. About 150 analysts had crammed into the ornate
Oriental-theme ballroom at the swank hotel to hear Jeff Skilling's prognostications. Skilling talked about Enron's growing trading business, its
success in energy services, and, of course, a little bit about pipelines. By
midmorning the price of Enron stock was ramping steadily upward,
climbing $2 or more per hour. The analysts in the room began suspecting that something was afoot. A year earlier, in the same room, Skilling
had announced the formation of Azurix, Enron's water business. And
there had been lots of rumors. A month earlier, Skilling and other
Enron officials had made the rounds in Manhattan, talking with stock
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193
reporter from Fortune. "They have zero experience that I know of."3
Sidgmore is now MCI WorldCom's CEO.
Despite the gas giant's lack of experience, Enron's acolytes were
singing hosannas to Skilling and his crew. The response from Merrill
Lynch analyst Donate Eassey was almost embarrassing. Eassey didn't
just suspend his skepticism, he put it through the nearest shredder, then
burned what was left over. Easseyapparently relying on numbers provided by Enron, which pegged its broadband trading revenues at $13.6
billion per year by 2.004estimated that Enron's operating profits from
broadband would total $2.1 billion within four years. "They said the
natural gas market would not open up in the 1980s, and it has in a big
way," said Eassey. "It was the same with electricity. All the naysayers
out there for broadband will be wrong, too."4
Raymond Niles, director of integrated gas and power research at
Salomon Smith Barney Inc. in New York, jumped on the bandwagon,
too. "Trading bandwidth is a home run for the companies that traded
energy commodities," he said. Niles told reporters that Enron would
succeed in the bandwidth provisioning and trading business because it
would be able to transfer the skills it learned in trading energy to the
new business.5
It wouldn't be the first time the analysts were wrong about Enron.
And if only they'd bothered to check out the qualifications of Enron
Broadband Services' new boss, they might have been a wee bit more
skeptical.
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tralia, riding motorcycles in Mexico) that meant that any old motorcycle just wouldn't do. Hondas and Harleys were too pedestrian. Rice
wanted more flash, more horsepower, and since money was never a
concern, he ordered three of the rarest motorcycles in the world.
According to sources at Enron Broadband, he bought two bikes for
Enron and one for himself. The source says Rice paid for the bikes with
his credit card so he could get the frequent-flyer miles that came with
the big purchase. By the way, the source says Rice paid Enron for the
Hellcat that he ordered.
Most people have never heard of Confederate Motorcycles. But
don't worry. Even hard-core motorcycle enthusiasts look puzzled when
asked if they know who makes the Hellcat. That's because Confederate,
based in Abita Springs, Louisiana, has only built a few hundred motorcycles since it went into production in 1997. The company's hand-built
machines have become a favorite of the motorcycle cognoscenti and
what Confederate founder Matt Chambers calls "super net-worth individuals." And since Rice was both racing cognoscenti and "super networth," he ordered the Hellcats. Never mind that each motorcycle cost
about $30,000 or that they were hardly the type of machinery that
Enron Broadband Services needed to succeed.
Although Rice shared the title of co-CEO of Enron Broadband Services with an old Portland General guy, Joe Hirko, it was clear to
almost everyone at the company that Rice was the one in charge. Rice
was close to Skilling, and no one believed that Hirko was going to stay
very long. Hirko left Enron a few months after the analysts' meeting,
but not before cashing out Enron stock worth $35.1 million.
Rice figured his new company needed an image. The badder that
image, the better. And the Hellcat is one baaaaad machine. Lower slung
than a Harley, the Hellcat has a bigger engine, lighter frame, and
sleeker design than a run-of-the-mill road hog.6 It's a bike designed to
turn heads, not corners. If you want to ride it, fine. But as Chambers
explained, his company builds the "Bentley or Duesenberg of motorcycles. It's not an everyday rider." In other words, the Confederate Hellcat is just flat impractical for transportation. However, as office
195
furniture for a telecom start-up with billions to spend, it's perfect. And
though a stock Hellcat is certainly a fine-looking machine, Rice wanted
a little bit extra. So he spent another $3,000 or so having one of the
bikes customized at a small motorcycle shop in West Houston. The
tank was painted maroon and black with "Enron Broadband" emblazoned on each side. The transmission case was adorned with Enron's
multicolored tilted-E logo. In addition, Rice had the words "Enron
Broadband" etched in a circular fashion into the metal of the transmission case. In the middle of that, in cursive script, was etched "Bandwidth hog."
The coup de grace was on the speedometer, a little custom number
that undoubtedly cost several hundred bucks. Rather than have the
readout on the dial denoted in mph (for miles per hour) Rice had the
dial read Gb/s, for gigabits per second. It was an expensive little fillip,
but money was no object. Enron Broadband Services and Ken Rice
were on a mission. That mission, it appears, was to spend lots of
money very quickly. And Rice certainly succeeded at that task.
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at Enron. Men were attracted by his sense of humor. Women found him
to be "an attractive man in a boyish sort of way," recalled a woman
who had worked at Enron. Within a few years of his promotion, Rice
was one of Enron's best salesmen. He was also gaining a reputation as
an inveterate philanderer. Despite being married since 1981 to his wife,
Teresa, Rice was, according to several sources within Enron, seducing a
number of young analysts and associates at the company throughout
the early 19905. His well-known affair with Amanda Martin started
sometime in the mid-1990s.
Rice's extracurricular activities did not diminish his value to Enron,
particularly when the company was trying to prove the concept of the
Gas Bank. To make the concept work, Enron needed to sell some big,
long-term gas supply deals. And it wasn't having much success. That
changed in 1991 when Rice helped close the New York Power Authority
gas supply contract. That deal, along with another one the following
year, with Sithe Energy, made Rice's reputation. They helped prove
Skilling's Gas Bank could work, and Skilling was extremely loyal to people like Rice and Lou Pai, who'd been selling and trading gas with him
since the earliest days of the Gas Bank. Skilling had approved huge
bonuses for Rice on those early gas deals and later, from his stint trading
electricity. So for the rest of the decade, Ken Rice coasted, cheated on his
wife, and raced expensive automobiles. By the time he got to Enron
Broadband Services, he'd made so much money he didn't have to work.
And he didn't. Although Rice was the CEO and chairman of Enron
Broadband Services, he didn't go to work every day. Instead, he'd show
up at the office three, sometimes four times a week. Often dressed in
jeans, cowboy boots, and a polo shirt, he'd check the Bloomberg terminal for the latest quotes on his stock portfolio and attend a few meetings. But even then, he was hardly the most diligent employee. "He'd
watch cartoons during meetings," said one former Enron Broadband
Services employee. "We had a wireless high-speed network in the building so he'd turn on his laptop and watch cartoons while we tried to do
meetings. And he'd tell everybody to watch it with him." Another
employee, who confirmed the cartoon episode, said Rice was simply a
"six-year-old in a forty-year-old's body."
197
Always interested in cars and racing, the newly rich Rice became
enamored with Ferraris. And since he had so much time on his hands,
and EBS had so much money, Rice had the neophyte telecom company
sponsor a Ferrari race car that he and other EBS employees then followed during the racing season. The cost of the sponsorship to Enron:
$120,000. Rice personally owned two of the super-swank Italian sports
cars, a 360 (cost: about $160,000) he used for racing and a 550
Marinello (about $200,000) that he drove to work and around town.
Although Rice quickly figured out ways to spend Enron's money at
EBS, he didn't give much thoughtand apparently didn't carehow
his company was going to make money. And several insiders warned
Rice that the company's bandwidth trading business model was fundamentally flawed.
But Rice and his second in command, Kevin Hannon, didn't listen.
That wasn't overly surprising. Rice was watching cartoons. Hannon
already knew it all. Hannon, the president and chief operating officer
of Enron Broadband, was a longtime trader. He'd risen through the
ranks to become one of Enron's top executives. He was also one of
Skilling's key cronies, which was the only qualification needed to run a
billion-dollar telecom business.
Hannon was an Easterner, an MBA, and a real creep. A former risk
manager in the natural gas trading unit at Banker's Trust, Hannon was
hired by Enron in the early 19903 to help set up the company's gas trading operations. He went on to manage all of the company's trading
operations in North America before moving to the broadband unit. It's
safe to say that almost no one at Enron liked him. Known for his hairtrigger temper and surfeit of self-importance, Hannon would loudly
berate his employees for little or no reason. One female assistant who
worked at Enron Broadband and dealt with Hannon on numerous occasions, summed up her feelings toward him by saying, "He's just slimy."
Gelatinous or genteel, Hannon was out of his league when it came
to telecom. One executive in the broadband unit recalls going into
Hannon's office a few months after the former gas trader had begun
working there. The executive was describing the details of provisioning
a DS-3 circuitwhich can carry about 45 megabits of information per
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By late February 2000, Andy Fastow had succeeded in enough financial foolishness at
Enron to be both Big Rich and Big Important.
So he bought a house in River Oaks.
It was only fitting. Fastow's wife, the former Lea Weingarten, was
an heiress with deep roots in River Oaks. Lea's aunt, Joan Schnitzer, a
principal beneficiary of the Weingarten real estate fortune, had a house
in River Oaks. So did her father, Jack Weingarten. A woman like Lea,
the daughter of a former Miss Israel, a stylish woman with a lofty
Houston pedigree, belonged there.
Other Enron Big Shots already lived in the 77019 zip code. Ken Lay
had been in River Oaks for years. Jeff Skilling and Rebecca Mark lived
there, too. So it made sense that when Andy Fastow started pulling
down the big money, he bought a house on Del Monte Drive in the
heart of River Oaks. The property deal, closed on February 2.8, 2000,
cost a reported $1.5 million. The house on the property was perfectly
serviceable. The Harris County Appraisal District had appraised the
value of the home alone at $388,000. But it was completely unsuitable
for a Big Shot. Lea and Andy were going to tear it down and build
another, bigger, grander house. Their house at 3005 Del Monte
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studied both economics and Chinese. While at Tufts, he met Lea Weingarten. The two began dating and later married. Fastow graduated
magna cum laude from Tufts in 1983. About that time, he and Lea
moved to Chicago, where both of them earned their MBAs at Northwestern University. They also both got jobs at Continental Bank, where
Andy worked on troubled loans, leveraged buyouts, and other deals.
And though Andy was fairly well regarded there, his wife, Lea, was put
on Continental's fast track. One source, who claims to be a "good
friend of Andy's," said that Lea "was the brains in the family. Andy
was always very cocky, just never very bright."
In late 1989 or early 1990, the source says that Lea's father, Jack
Weingarten, introduced Andy to Jeffrey Skilling. A few months later,
the Fastows were on their way to Houston. Both of them got jobs at
Enron. Lea worked in the treasurer's office in the Corporate Finance
Department. Andy went to work for Jeffrey Skilling at Enron Finance.
Working with Skilling, Fastow learned how to structure complicated
deals like the one with Flores & Rucks. He also absorbed Skilling's
methods of managing people and his view of the world.
"Fastow very much admired Skilling," commented one source who
had worked with both men. "He and Skilling were very close. He
wanted to be big and powerful like Skilling."
"If you ever crossed him, he never forgot and would do everything
possible to make life miserable for you," said the source. "I'd get calls
from bankers complaining because Andy was a pain to deal with.
They'd be in meetings and Andy would start yelling obscenities. He'd
just fly off the handle. If you were a banker and didn't give him what
he wanted, he remembered. He had a short temper and was a vengeful
person."
Fastow stayed at Enron Gas Services until about 1996, when
Skilling promoted him to lead the company's new retail power business.
The idea was to sell power to residential customers in newly deregulated markets like California. But the concept was flawed. Profit margins in the residential electricity market are razor thin. Also, Enron was
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with his two young sons, helping coach their sports teams. He played
tennis and the trombone. He did fund-raising for Houston's Holocaust
Museum and other charities. And he also became an art snob.
Even though Andy and Lea Fastow finally had the house in River
Oaks, they were never going to belong in Houston society unless they
got plugged in with the arts. The oil and gas nouveau riche have always
bought legitimacy and respect through the arts, and Houston was no
exception. Hugh Roy Cullen had helped bankroll the launching of the
Museum of Fine Arts in Houston. Dominique de Menil, heiress to the
Schlumberger megafortune, funded the creation of a museum, the
Menil Collection. So in the late 19905, he and Lea, particularly Lea,
began reading up on modern art and contemporary artists. She started
buying art and attending lectures. They even began thinking about
ways to start giving away their vast new wealth.
Yes, by early 2.000, things could not have been better. Enron's stock
was sky-high.
Lea and Andy had a berth in River Oaks. They were going to build
an n,500-square-foot home that would be one of the finest in the
entire neighborhood. It would cost them $1.5 million or more, but that
wasn't a problem. Lea and Andy Fastow were rolling in dough. They
had so much money they'd have their own foundationthe Fastow
Family Foundationand all before Andy hit forty.
Andy and Lea had already figured out the return on the Southampton deal he'd done with Enron. For an investment of $15,000, he was
going to clear about $4.5 million. They would put all of that money
into the foundation. His bonuses and salary would cover all the decorating expenses for the new house. As the managing partner of the myriad partnerships he'd set up, there were plenty of other opportunities to
make big money from Enron. And he was going to take advantage of as
many as he could.
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Lanna wanted her share of the fortune that Lou had been accumulating
at Enron. So Lou Pai began doing what lots of other Enron insiders
were doing. He began selling his Enron stock.
Pai didn't mind. He already had more money, stock, and real estate
than he'd ever dreamed possible. He was going to stay quiet and out of
sight, just like he always had, but now he could do it in style with his
babe-a-licious girlfriend, a former topless dancer named Melanie
Fewell.1 Pai had been sleeping with Fewell since the early 19908 even
though both of them were married. And in 1996, according to the New
York Times, Fewell's then-husband named Lou Pai as a problem in
their marriage, describing Pai in court documents as her "paramour"
and employer.2 But soon, both Pai and Fewell would be free, and they
were going to have plenty of space to keep their privacy. For instance,
they could go to Pai's own 14,000-foot-tall mountain.
Reportedly the only person in Colorado to own his own "fourteener," Pai has title to a huge ranch that contains Culebra Peak, which
at 14,047 feet is the fifty-first-highest point in the lower forty-eight
states. The 77,50o-acre parcel formerly known as the Taylor Ranch has
long been controversial with the largely Hispanic locals in San Luis.
Several generations of local people had been cutting wood, hunting,
fishing, pasturing their livestock, and recreating on the property, thanks
to an 1844 Mexican land grant. Maria Mondragon-Valdez, a historian
and community activist who is doing her doctoral dissertation at the
University of New Mexico on land rights in Colorado and has
researched the long history of the Culebra Peak land grant, said that
the people in San Luis (the oldest town in Colorado) have grown used
to absentee landowners like Pai. But there was something different
about the way Pai went about his business. The previous owner, Jack
Taylor, who had controlled the land since the 19605, at least lived on
the land and occasionally talked to the locals. Lou Pai did everything,
said Valdez, "clothed in secrecy and insulated from public contact."
Pai began buying the Taylor Ranch in 1997, and by 1999, through a
series of interconnected corporations, Pai controlled the entire ranch.
And he immediately began excluding everyone from the property.
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Where the Taylors had let mountaineers access the peak for a fee, Pai
kept everybody out. His crews erected stout fences and bulldozed a
security path immediately behind the fencing. He put up lots of big signs
that bore "No Trespassing" in bold letters. The signs carried an additional message just below, which read "For Any Reason Whatsoever."3
Pai was going to do whatever he damn well pleased on his ranch.
Screw the locals and their ancestral rights to the land and the water of
Culebra. For decades, the farmers in the valley below Culebra had used
earthen acequias to guide water from the mountain into their fields.
Acequias, long ditch systems that transport water, are found throughout
Texas, New Mexico, and Colorado. They were introduced into the New
World by Spanish missionaries who learned the technique from the
Moors. According to Valdez, the acequias below Culebra Peak are the
oldest in Colorado and hold the state's oldest recognized water rights.
When Pai took over, Valdez continued, he began damming the mountain
streams to create a Chinese garden effect on his ranch, thereby depriving
his downstream amigos of much of the water that had previously
flowed their way. Pai's fences, locked gates, and impatient security men
also hindered the locals' efforts to open and close the water gates
which sit on Pai's landthat divert water into the acequias.
Either by design or by happenstance, Lou Pai had made himself into
a villain worthy of The Milagro Beanfield War, but he didn't give a
damn. Many of the people who lived around San Luis in the heart of
the Sangre de Cristo mountain range had hated the previous owner of
the ranch, Jack Taylor, but they quickly grew to have a particular
loathing for Lou Pai, America's most unlikely land baron.
Lou Lung Pai was born in Nanjing, China, on June 23, 1947. His father,
Shih-i Pai, who died in 1996, was a highly regarded aeronautical engineer who did pioneering research into the drag and lift characteristics of
airplanes and missiles. The elder Pai moved permanently to the United
States in the year of Lou Pai's birth to take a teaching job at Cornell University. In 1953, he left Cornell for a job at the University of Maryland,
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where he stayed until he retired in 1983. Lou Pai, one of four children,
got his undergraduate degree from the University of Maryland. He
served two years in the U.S. Army before returning to Maryland to get
his master's degree in economics. He worked in Washington, D.C., for a
few years, then moved to Houston in the 19805 to take a job with
Conoco. In 1987, he was hired at Enron by Bruce Stram, a friend from
graduate school, to work in the company's strategic planning department. Pai's work in planning went well, but he had a gift for trading, a
gift that was discovered shortly after Jeff Skilling began setting up the
company's Gas Bank. Pai proved himself so quickly that Skilling feared
Pai would defect and go to another Houston company, Natural Gas
Clearinghouse (the company that later became Dynegy).
Pai was quickly promoted to vice president. But Pai's supervisor at
the time regretted the move almost immediately. By promoting Pai, said
the executive, "I violated two principles of mine. First, the person
should take a leadership role. Second, the person going into the job
needs to take on more responsibility and carry the corporate flag. Turns
out I violated both of them. Pai didn't have leadership capability and he
didn't have management capabilities."
But management capability was never a prerequisite for advancement at Enron under Jeff Skilling. Pai was proof of that. He was the
most asocial of those in Skilling's inner circle. Pai was happiest when he
was left alone, and by being one of Skilling's chosen few, he was able to
achieve that goal throughout his Enron tenure. "I'd get on the elevator
with him and he wouldn't make eye contact. He was so strange," one
woman who worked with Pai remembered.
Stories of Pai's fascination with strippers were legion at Enron. One
executive recalled getting an expense report from Pai in 1990, shortly
after Pai began working for him. "It was $757 for one lunch. He and
two or three coworkers had gone to Rick's [a Houston strip club]. I said,
'I'm not approving this. You are going to have to take care of this yourself.' I couldn't understand why he would do that kind of thing. You just
don't do that in business." But that executive didn't stay at Enron long.
And Pai reverted to his old ways, ways that Skilling tolerated.
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In other cases, the company used mark-to-market accounting to create the illusion of profits. In one deal, signed in February 2001 with
Quaker Oats, Enron Energy Services agreed to supply fifteen different
Quaker plants with natural gas, electricity, and trained personnel to
maintain the company's boilers. Under the terms of the deal, which was
later reported by the Financial Times, the company guaranteed Quaker
would save about $4.4 million per year in energy costs. Then, before
turning on a single light, Enron projected it would make $36.8 million
profits over the life of the ten-year deal and immediately booked $23.4
million of that amount.4
"Everybody I talked to always thought the mark-to-market thing
would come back and bite us," said one veteran of Enron Energy Services. "You always had to find new deals to cover the previous deals."
And just as the traders on Enron's trading floor got paid to do big
trades, the deal makers at Enron Energy Services got paid to book big
deals, regardless of whether they were profitable or not. "The deal
makers got paid all their bonuses up-front" when their deals closed,
said one of Pai's coworkers. "We didn't know if a deal would be good
or bad or ugly. I kept arguing that we need to stretch out these bonuses
and pay them out based on their success. But Lou always wanted to
have them paid right away."
According to his coworkers at Enron Energy Services, Pai never
appeared overly concerned about his company's profitability. Those
same coworkers admired his intellect, if not his work ethic.
"Pai had a brilliant mind. He could think of several complicated
things at one time," one source remarked. "While everyone was struggling to understand one part of the problem, he had everything figured
out. Everyone who met him was impressed with him." However, few
people thought he applied himself once he got to the energy services
business. He rarely took phone calls. He often sat in his office alone,
reading the paper. Another source said Pai would often come in at 9
A.M. and leave by midafternoon. "And he never took any work
home."
What Pai lacked in Protestant work ethic, he made up for in his
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compensation negotiation skills. In the early days of the trading business, "Pai would be in here every few weeks trying to renegotiate his
contract," said one Enron veteran. "I'd throw him out of my office. But
Skilling would always agree to sweeten his deal." Another longtime
Enron employee who worked with Pai in the trading business said,
"Everything Lou wanted was stock options. It was stock, stock, stock.
Then when he went to Enron Energy Services, he got a whole other
bunch of stock in that deal."
Stock and stock options were the cocaine that drove the Internet Bubble. And Enron was the biggest junkie on Wall Street. Enron was more
aggressive in awarding options than almost any other company in the
Fortune 500. By the end of 2000, over 13 percent of all of Enron's outstanding stock was held in options, and a big hunk of them were held
by executives like Pai.
Skilling and Enron chairman Ken Lay could dump Enron stock
options on Pai and the rest of the favored few because the accounting
treatment for stock options was so favorable. For companies, giving
stock options was better than a free lunch: It was a lunch the company
got paid to eat.
If Enron paid Pai a bonus of, say, $1 million in cash, the company
would have had to report that expense on its profit-and-loss statement.
But with options, even though Enron incurred real costs in granting
them to Pai, the company didn't have to record the expense on its
profit-and-loss statement. Furthermore, Enron (and every other company that used options) could deduct the cost of the options as an
expense from its tax liability. All of that means that corporate honchos
can reward themselves with a boatload (or two) of stock options without hurting the company's profit reports. Then, when the options are
exercised, the company could treat the appreciation in the value of the
sharesthe option holder's profitas an expense for tax purposes.
By the end of 2000, Enron's incredibly generous stock option ploy
turned what would have been a federal income tax bill of $112 million
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in 000 into a $2.7 8-million refund. That's better than any free lunch.
Of course, Enron wasn't the only company using options to its advantage. Between 1994 and 1998, the number of options granted by companies in the Standard & Poor's 500 jumped from 1.6 billion options to
over 4.4 billion. And all of those options had a big effect on those companies' profits. Between 1995 and 2.000, the average earnings growth
rate of America's biggest companies would have been reduced by nearly
15 percent if those companies had been required to report their stock
option grants as expenses on their financial statements.
Stock options may be better than free for corporate fat cats, but
they can cost shareholders real American money. The most commonly
recognized problem is shareholder dilution. When an executive exercises an option on, say, i million shares of stock, the company must
add those shares to the existing number of outstanding shares. Thus, a
company that had 100 million shares outstanding before the executive
exercised the option would have 101 million shares available on the
open market after the transaction. That hurts the existing shareholders
because their shares have been diluted (albeit fractionally) by the addition of the new shares.
To combat the problem of dilution, many companies buy back their
shares on the open market after executives exercise their options. The
buyback reduces dilution, but it reduces the amount of cash available
to the company for other expenses like equipment and inventory. If the
option grants are really large, the company may even borrow money to
buy back its shares, a move that weakens its balance sheet.
About the same time Lou Pai began selling huge blocks of his Enron
stock, Warren Buffett, the chairman and CEO of Berkshire Hathaway
Inc. and the unofficial conscience of corporate Americaprotested
the widespread use of stock options by American companies. In his
company's annual report, Buffett wrote, "Whatever the merits of
options may be, their accounting treatment is outrageous." In August
1999, Federal Reserve chairman Alan Greenspan estimated that excessive use of options had caused American companies to overstate their
profits by i to 2. percentage points over the previous five years.
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But those factors paled in comparison to the real danger of the massive stock option grants that had been passed out by Enron: They created a huge incentive for the company's top management to cut
corners, to keep important information hidden.
Enron's annual reports show just how effectively Skilling was using
those options. During the Kinder era, the number of stock options
available to be granted to employees stayed relatively constant, and by
the time of his departure, Enron had about 2.5.4 million shares of its
stock tied up in outstanding options. However, at the end of 1997,
Skilling's first year as president and COO, the number of outstanding
options that Enron employees could exercise had ballooned to 39.4
million shares. By 1999, Skilling was handing out Enron stock options
like they were nothing more than cheap candy. By the end of that year,
Enron had granted more than 93.5 million shares of stock to its
employees in the form of optionsincredible, and nearly quadruple the
number that existed under the more fiscally conservative Kinder.
Skilling had turned Enron into a stock option colossus. And with
their future potential wealth closely tied to the appreciation of the company's stock, Enron's top executives like Fastow, Pai, and Skilling had
millions of reasons to keep bad deals and bad debts from surfacing in
the company's financial reports.
By late spring 2,000, Lou Pai was in his early fiftiesolder than any
of the other members of Skilling's mafia. And he had more responsibility than almost any of the other members of the Enron Executive Committee. He was the chairman of The New Power Company, a company
that Enron was betting would be able to gain market share in retail
energy markets by offering homeowners and others electricity and gas
at prices lower than what they were paying their local utilities. Enron
had placed a huge wager on New Power, which was nearly ready for its
initial public offering.
In addition, Pai had already been the chairman and CEO of the
energy services business for three years. He was ready to slow down.
He'd prowled Houston's titty bars for more than a decade, and he'd
found the one woman who really lit his fire. And besides, he was
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already Big Rich. He'd spent about $2,3 million buying Culebra Peak
and the ranch in Colorado. And he still owned about a zillion Enron
stock options. It was time to sell and move on with his life. So he did
just that. On May 31, 2000, Lou Pai became one of the first Enron Big
Shots to take a huge payout under the company's supergenerous stock
option scheme. When the markets closed that day, Pai had sold $79.9
million worth of his Enron stock.
Lou Pai was cashing out. And there was more insider selling to
come. Lots more.
SUMMER 2000
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company's European trading operations. Other top execs like Lou Pai
had been involved in trading for years.
Enron's massive new edifice to itself, a forty-story, i.2-millionsquare-foot building was going to be a monument to trading. The
building, designed by acclaimed architect Cesar Pelli, would have four
trading floors each big enough for 500 "transaction desks"with
state-of-the-art communications systems. Ken Lay and Jeff Skilling
would move their offices from the fiftieth floor of the old building
down to the seventh floor of the new one. Instead of overlooking all of
Houston, their new offices would be on a balcony overlooking one of
the new trading floors. And they wouldn't have to take elevators to get
to the traders: Two snazzy curved stairways were going to connect their
floor with the trading area.1
The new tower had been under construction for nearly a year and
was costing Enron a fortune. Pelli's design, which would mimic the
glass-sheathed oval tower Enron already occupied, was going to give
Enron the most expensive building in downtown Houston. The highest
price ever paid for a downtown office building was about $170 per
square foot. The new Enron tower was going to cost about $50 per
square foot, a figure that would make the final bill about $300
million.2
Enron was wasting even more money in Europe. The company's
European trading operations were located in an impressive new building dubbed Enron House, located at 40 Grosvenor Place, in the heart of
London, on land owned by the Duke of Westminster. Although the
building cost $74 million to construct, Enron spent another $30 million
in bringing it up to the company's lofty standards. When the company
moved into Enron House in November 1999, the top executives,
including Enron Europe CEO Mark Frevert, could sit in their top-floor
offices and look down on rear gardens at Buckingham Palace. Rent for
the new digs? A bargain at a mere 8 million a year.
But cost control in Houston or London was never a consideration
for Skilling and Lay. After all, EnronOnline, the company's new web
site, was the toast of cyberspace. In the few months since it had been
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launched in November 1999, the web site had quickly become the
biggest e-commerce site the Internet had ever seen. The trading site had
been the brainchild of a trader, of course, named Louise Kitchen, a
brash young Brit who had been Enron's head natural gas trader in
Europe. Cocky and impatient, Kitchen was emblematic of Skilling's
new version of Enron. At just thirty-one years old, she was young, she
was rich (in 2001, her total pay from Enron was $3.47 million), and
she believed there was no end to what sheand Enronmight do.
While she and her team were developing the site, Kitchen said, "I
didn't need a pat on the back from Ken Lay or Jeff Skilling. It was obvious that we should have been doing this ages ago."
Kitchen's attitude was typical among the traders. They were the
iiber-Enroners, the ultimate Masters of the Universe. "The traders
didn't kowtow to anybody," recalled John Allario, who spent five years
at Enron. The traders made the biggest salaries and the biggest
bonuses, and they were the ones Jeff Skilling courted. When the traders
"decided to do a trade, they weren't hindered by anything else Enron
was doing."
Kitchen, along with another thirty-something trader, a Canadian
named John Lavorato, were rapidly consolidating their power within
Enron. And within a few months of EnronOnline's debut, the pair was
heading all of Enron's North American trading operations. There were
hundreds of traders, lined up in banks of computer screens, keyboards,
telephones, and adrenaline. In the first five months of 2000 alone, the
web site did 110,000 transactions with a total value exceeding $45 billion. Deals could be done in seconds, rather than minutes or hours.
Electricity, natural gas, coal, oil, refined products, bandwidth,
paper, plastics, petrochemicals, and even clean air credits were for sale
on Enron's web site. Within a few weeks of its launch in November
1999, EnronOnline was the biggest e-commerce entity in the world. In
all, the company was selling over 800 different products.
EnronOnline was the logical outgrowth of Enron's gas trading business, which was launched shortly after Skilling conceived the Gas Bank
concept. What had been done by phone and fax was now being done
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on the World Wide Web. And the gas business was a primary reason
for Enron's trading prowess. The company's trading business surged, in
large part, because of tremendous increases in gas consumption in the
United States. Between 1983 and 2.000, demand for natural gas in
America rose by nearly 30 percent, to zz.5 trillion cubic feet per year.
Enron transferred what it learned in gas to the electricity business.
Once confined to trading among utilities, Enron elbowed its way into
electricity trading in the mid-1990s. The company even bought Portland General Electric to assure itself of a place at the utility table. But
the Portland General purchase was, by any measure, a failure for
Enron. The company was in nearly constant battles with state regulators in Oregon and by 1999, just three years after it announced the purchase of the utility, Enron announced it would sell the power company
to Sierra Pacific Resources. With or without Portland General, Enron
had become a monster in megawatts.
Enron was selling gas and power, but all the while it was collecting
still more information that provided a constant feedback loop. Enron
owned pipelines and power plants, and with EnronOnline, it could
instantly tell which direction the market was going. It could also tell
who was buying, who was selling, and where it should be placing its
own bets in the marketplace.
"We'd get a lot of information because our pipelines were coast to
coast and border to border," said one trader who spent many years
trading gas for Enron. "We had the models, the computer
systems... Enron gave you every tool that was ever needed for you to
be successful. You just had to pick the right side of the market and have
the balls to put on big positions."
In a very short time, Enron had remade itself from pipeline company to the largest energy marketer in the country. But Skilling wasn't
satisfied. He wanted more. So in May zooo, Enron announced it would
buy London-based MG pic, one of the biggest metals traders in the
world, for $446 million. Ken Lay said the deal would allow Enron to
claim a major role in the $izo-billion-per-year metals market. "Our
business model, which we have proven in the natural gas and electricity
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that Company Z come up with the cash value of the contract so that
Enron would not be left holding the bag. But the material adverse
change clause works both ways. Company Z could also invoke the
clause if a catastrophe befell Enron. But no one would ever demand
that Enron would have to provide cash under the material adverse
change. Enron was too strong to fail. Right?
The institution of the material adverse change clause was just one
way that Enron dominated the trading business. And Skilling became
convinced that Enron simply couldn't lose. In the lingo of Rich Kinder,
Skilling began "smoking his own dope."
Skilling had made Enron into the trading company that everyone
was talking about. Enron had become the ^oo-pound gorilla in the
marketplace. It didn't just own the casino. On any given deal, Enron
could be the house, the dealer, the oddsmaker, and the guy across the
table you're trying to beat in diesel fuel futures, gas futures, or the California electricity market. With all of those advantages, Enron's trading
business must have been a cash machine. Right?
Wrong.
Like every business Jeff Skilling created while he was piloting
Enron, the trading business was a loser. Sure, trading was glamorous
and sexy, but it generated virtually no cash for Enron. And that was a
problem. Instead, Enron's trading operation had an insatiable appetite
for cash. Unlike other on-line energy marketplaces like Altra or the
consumer goods auction site, eBaywhich matches buyers and sellers
for a feeEnronOnline was the principal in every transaction. That's a
very expensive place to be.
If a seller agreed on Enron's posted price for, say, natural gas to be
delivered on a certain date, that seller could sell it immediately to
Enron. The company would then take title to the gas and try to sell it to
another party. That may not sound like a big deal, but by mid-zooo,
Enron was doing several billion dollars worth of trades every day. And
because it was in the middle of every transaction, Enron would have to
hold some of those commodities for days or even weeks before it could
get the price that it wanted on its trades. That meant Enron had to have
221
billions of dollars in cash at the ready. That sort of ready cash needed
to clear and fund each sale and purchase often called a company's
"float"can be enormously expensive. And the bigger the float, the
bigger the expense.
Every day that Enron held onto a big position in a commodity, it
had to pay interest on the money it borrowed to take that position. For
instance, one of Enron's gas traders might be betting that gas prices
would rise and therefore go "long" on gas contracts in the amount of
500 million cubic feet of gas. At $3 per 1,000 cubic feet, the gas could
be worth $1.5 million. That might not sound like much. But Enron had
hundreds of traders. Some going long, others going short in gas and
dozens of other commodities. Supporting all of those positions required
huge amounts of capital. And as the number of transactions handled by
EnronOnline grew, so did its appetite for capital. The new operation
had to have enough cash to keep a liquid market in 800 different products, each of which was seeing a big surge in volume.
In the first six months of 2000, Enron borrowed over $3.4 billion to
finance its operations. The company's cash flow from operations was a
negative $547 million. Enron was losing money real money, cash
moneyhand over fist by just being in business. Interest expenses were
surging.
By the end June 2000, the Enron company was paying about $2.
million per day in interest to banks and other lenders. The $376 million
in interest charges for the first half of 2000 was more than Enron paid
in all of 1996 (the last year of Rich Kinder's tenure), during which the
company's total interest costs were $290 million. Of course, Skilling
was able to make Enron's revenue look great. But once again, the surging revenue was due to the illusion of mark-to-market accounting. If
Enron signed a five-year electricity supply contract for a department
store, all of the revenue was booked immediately. With tricks like that
in near-constant supply, it's not surprising that during the first six
months of the year, Enron's revenues totaled $30 billion, nearly double
the $17.3 billion recorded for the period a year earlier.
Beyond that, personnel costs, particularly in Europe, were out of
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control. At its peak, Enron Europe had about 5,000 employees, the vast
majority of whom were trying to profit from the continent's electricity
market, a sector that was only about two-thirds the size of the North
American power market. At one point, salaries alone for Enron Europe
totaled about $150 million per year. But Skilling was unconcerned, said
one Enron Europe veteran. "Skilling never worried about costs. He
only worried about revenues. If at the end of the year you had started
with a $10 million target and you came back with $iz million, you
were a hero. And it didn't matter if you'd spent $15 million to make
that $12 million."
Despite EnronOnline's voracious appetite for capital, Skilling was
able to convince a nearly constant parade of reporters that Enron's trading business was invincible. Other companies were going to explode as
Enron figured out how to buy and sell every part of an individual company's traditional business. Enron was going to intermediate everything,
commoditize everything. Just as Ford Motor Company didn't have to
own the steel mill to build cars, Enron was going to speed the breakup of
every business in the world into its individual parts.
"We believe that markets are the best way to order or organize an
industrial enterprise," Skilling told the Financial Times in June 2000.
"You are going to see the deintegration of the business systems we have
all grown up with."3
If Enron was going to help that "deintegration," its trading business
was going to have to keep growing. And that meant Enron would need
more capital, lots more capital. But there was a problem: Enron could
not raise capital by adding more debt. More debt on its balance sheet
might lower the company's credit rating, which would further increase
the company's already high interest costs.
Skilling needed more cash but no more debt. Andy Fastow was
going to have to do more financial engineering. And Fastow, of course,
was more than willing to help.
LJM2
SUMMER 2000
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LJM2
225
Nowa Sarzyna, Enron and Whitewing were forced to buy back LJM's
share interest in the plant for $31.9 million. Fastow's company made
nearly $2 million by holding the asset for less than ninety days.
Fastow's special-purpose entities became a fast-and-dirty way for
Enron to manufacture additional revenues in a big hurry. In the last
eleven days of 1999, Fastow's companies did seven separate deals with
Enron. In addition to the power plant in Poland, Fastow's LJM2 entities borrowed $38.5 million from Whitewing, bought a stake in some
of Enron's loans, bought part of Enron's stake in a natural gas gathering system in the Gulf of Mexico, bought a stake in a trust Enron had
invested in called Yosemite, and bought part of Enron's stake in a company that provided financing for natural gas producers.
The advantage Fastow brought to Enron with the off-the-balancesheet entities was the ability to do deals quickly. Enron was "looking
for a quick way to sell assets to generate income," said one longtime
Enron finance person. "If you control both sides of the deal, you can
do it very quickly at any price you want. That's an advantage versus a
situation where you're trying to sell it to a third party, it might take a
year or more. It was a way for them to control the entire process."
Fastow helped Enron control the process through a flock of entities
with names like Osprey, Osprey Trust, Timberwolf, Bobcat, Egret, Condor, Rawhide, Sundance, Ponderosa, Harrier, Porcupine, and Mojave.
He also created a quartet of misbegotten entities known as the Raptors.
The sham deals quickly became one of Enron's main business units.
In 1999 alone, Fastow's deals inflated Enron's profits by $248
millionthat's more than one-fourth of the $893 million in profits
Enron reported that year. Fastow's key lieutenant in tending this financial house of cards was Michael Kopper, the Enron employee who
bought Enron's interest in the JEDI project in 1997. Kopper and his
domestic partner, William Dodson, owned the entity known as
Chewco, which had borrowed heavily in order to do the JEDI deal.
By 2000, Kopper and Fastow were working hand in hand. And Fastow was rewarding him. In 1999, it appears that Fastow helped Kopper
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get a bonus that was double the amount normally given to employees
at his level. Kopper, a graduate of Duke University and the London
School of Economics, was well liked by his coworkers at Enron. He
was smart and capable. But Kopper's coworkers said he also quickly
became enamored of the wealth that Fastow's partnerships were showering upon him. After that, "Kopper became Fastow's puppet," said
one senior Enron finance person who worked closely with both men.
The huge amounts of money coming from the partnerships
undoubtedly helped Kopper and the other Enron employees become
inured to Fastow's frequent screaming fits and temper tantrums. One of
Fastow's key aides was Ben Glisan, who became the company's treasurer in May zooo. Glisan succeeded Jeff McMahon, a former Arthur
Andersen employee who had complained to Enron president Jeff
Skilling about Fastow's dual-role position at Enron. Rather than
address McMahon's concerns, Skilling moved McMahon from his spot
as treasurer to another division at Enron.
Fastow's two-headed role at Enron allowed him to exact very good
deals when negotiating on behalf of LJM1 and LJM2. If an Enron
employee was pushing too hard for Enron's interests, Fastow would
retaliate. In one case, Fastow told an Enron lawyer, Jordan Mintz, to
fire one of his subordinates because he was "representing Enron too
aggressively" in some negotiations.
Another Enron finance executive felt Fastow couldn't be trusted in
negotiations or anything else. "Fastow would tell you anything you
wanted to hear to your face. He'd lie to your face. Then go somewhere
else and say something totally different."
Truth and trust apparently began to matter less and less to Glisan
and Kopper as they began seeing just how many spiffy baubles Fastow's
newfound wealth could buy. Fastow was partial to fancy watches. He
often wore a Franck Muller model known as a "Master Banker" (no
snickering, please), a spiffy analog watch that showed the time in three
different time zones. Its cost: about $9,000. Soon, Kopper and Glisan
were wearing Master Bankers, too.
Fastow made sure to share the wealth. The most lucrative deal came
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on March 20, 2000, when Fastow and his cronies set up Southampton
Place, L.P. The general partner of Southampton was yet another shell
company called Big Doe LLC. (Get it? Big Dough?) The bulk of the
money for Southampton came from Big Doe, which was controlled by
Kopper, and the Fastow Family Foundation, controlled by Andy Fastow. Those two entities each put $25,000 into Southampton. The other
investors in Southampton included Glisan; Kristina Mordaunt, an
Enron Broadband Services lawyer who had worked closely with Fastow
on LJM-related projects; and three other Enron employees.
Southampton was needed to clean up the derivatives mess Fastow
had created in June 1999 with the Rhythms NetConnections deal.
Remember Swap Sub and the put option on Rhythms stock that Enron
boughta put that was based on the value of Enron's own stock?
Sometime in March 2000, Enron's president, Jeff Skilling (who was
apparently informed and involved in manyif not allof the company's
off-the-balance-sheet deals) decided that the company's option deal with
Swap Sub was flawed. Skilling decided Enron should simply sell its
Rhythms stock and liquidate the put option it had with Swap Sub.
Fastow, wearing his LJM1 hat, convinced Enron that it should pay a
total of $16.7 million to Swap Sub to unwind the deal. (No one at
Enron knew that Swap Sub had just been purchased by Southampton.)
In exchange for the $16.7 million, Enron would get back the stock it
had originally given to Swap Sub and the put option Enron owned on
the Rhythms stock would be terminated. Enron's negotiator on the
deal, chief accounting officer Rick Causey, agreed to the price and the
deal was done.
Why Causey agreed to pay Southampton $16.7 isn't clear at all. In
fact, it was just plain boneheaded. Swap Sub owed Enron a ton of
money. The Rhythms put options, at the time the deal was canceled,
were worth $207 million to Enron because Rhythms stock had fallen
dramatically in value. Nevertheless, Fastow somehow persuaded
Causey, the eagle-eyed accountant, to pay Southampton big bucks to
get out of the Swap Sub deal. Causey's tough negotiating provided an
incredible windfall to Fastow and his partners in Southampton.
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On May i, 2000, about the same time Fastow, Kopper, and the others
were making enormous returns on the Southampton deal, Glisan and
Causey presented yet another Fastow-led deal to the company's Finance
Committee. The new deal, called Raptor, was described as a "risk management program to enable the Company to hedge the profit and loss
volatility of the Company's investments." The presentation said Fastow's company, LJM2, would be one of the main investors in the new
entity. It also identified some of the risks that came with the Raptor
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pledge a total of $1 billion worth of its stock to the Raptors. Like Swap
Sub, the Enron stock would provide the "capital" that the Raptors
needed to do transactions. In return, the Raptors would help Enron
lock in tens of millions of dollars in gains on stock it held in newly public companies like hardware maker Avici Systems and The New Power
Company, the energy company headed by Lou Pai that planned to sell
electric power to individual homeowners.
The solution to preserve the gains in Avici and New Power was the
same one that Fastow had come up with for the Rhythms deal: derivatives and more derivatives.
The Rhythms-Swap Sub transaction had used a put option. The
Raptor deals were based on a more complicated derivative, a contract
called a "total return swap." The total return swap that Enron got
from the Raptors allowed the companyin theoryto preserve its
investments in Avici and New Power. If the price of the stock in Avici
and New Power increased above a certain price, the Raptors would
benefit. The Raptors would get to keep any increase in the value of the
stock above that set price. If the stocks fell below the set price, the Raptors would be required to pay Enron the difference between the set
price and the current price.
But just as with Swap Sub, the Raptors were predicated on flawed
logic. The ability of the Raptors to pay Enron for any decline in the
value of Avici and the other stocks was based on the value of Enron
stock. If Avici and the other stocks declined in value at the same time
that Enron's stock declined in value, the Raptors wouldn't have enough
money to pay Enron back. Fastow may not have known it, but he'd
made a multibillion-dollar bet that Enron's stock wouldn't go down.
Given Enron's lofty stock price, it must have seemed like a good idea at
the time. And as one Enron managing director said, "It worked for a
few months. It worked like a charm."
Indeed it did. By November 2000, the notional value of the derivatives deals Enron had done with the Raptors totaled an astounding
$1.5 billion.
There was another bit of faulty thinking in the Raptor deals. In
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231
exchange for the loan of Enron stock, the Raptors gave Enron promissory notes pledging to repay the $i billion. So far, so good. However,
Fastow and Enron's bean counters made a fatal error in accounting for
the promissory note. It was a mistake that would come back to haunt
the company.
While the accountants slept, Enron's attorneys were starting to
worry about the Raptor deals. On September 1, 2.000, Stuart Zisman,
an attorney who'd been looking at the Raptors, sent an e-mail to his
superiors in Enron's legal department that said, "We have discovered
that a majority of the investments being introduced into the Raptor
Structure are bad ones. This is disconcerting... it might lead one to
believe that the financial books at Enron are being 'cooked' in order to
eliminate a drag on earnings."
Enron was cooking the books and Andy Fastow was the chef de cuisine. So where was Andersen this whole time? It was, as usual, cashing
Enron's checks. In exchange for its work on the Raptor deals, Andersen
charged Enron a total of $1.3 million.
Enron's bet on the Raptors, combined with Andersen's tacit
approval and Fastow's dual role as Enron CFO and off-the-balancesheet profiteer, was the kind of conflict of interest that federal investigators and regulators were always interested in. Those regulators
included people like Arthur Levitt.
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between the two firms. The event, the exec explained, "showed me that
those guys from Andersen were whores."
That kind of meeting would have been unimaginable a few decades
ago, when certified public accountants, and the firms they worked for,
were viewed as impartial arbiters of business. They were CPAs, certified
public accountants. Their duties were to their clients, sure, but they had
a larger duty to the public. And they took that duty seriously. But by
the late 19908, when Enron began barricading doorways that standard
had been irreparably erodedand it worried Arthur Levitt, the chairman of the Securities and Exchange Commission.
Throughout the mid- and late 19905, Levitt had observed the
changes infecting the once-honorable accounting profession. And to
Levitt, a former broker and former chairman of the American Stock
Exchange, nearly all of the things he was seeing were bad. In 1998, the
Tampa, Florida, office of Big Five accounting firm PricewaterhouseCoopers found that its employees were routinely buying stock in companies they audited. The news from Tampa forced the firm to do a
companywide audit of its partners' and managers' stock portfolios. In
January 2000, the firm said it had found 8,000 violations of its internal
policies prohibiting auditors from owning stock in companies the firm
audited. About half of PricewaterhouseCoopers's partners had conflicts
of interest.2
The blurring of the line between the accounting firms' auditing business and their consulting practices was even more worrisome. Figures
collected by the SEC, an agency created in 1934 to protect American
investors, found a dramatic rise in the amount of consulting work being
done by the accounting firms. In 1981, the average accounting firm
derived just 15 percent of its income from consulting services. By 1999,
firms were collecting half of their annual revenues from management
consulting and other nonaudit services. That consulting income was
particularly important for the "Big Five" accounting firms: KPMG,
Ernst & Young, Deloitte & Touche, PricewaterhouseCoopers, and
Arthur Andersen.
The surge in consulting coincided with some terrible auditing work
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by the accountants. In the seven previous years, investors had lost some
$88 billion in market value because of auditing failures. 3 Companies
were restating their annual financials with alarming regularity (a
restatement occurs after a company realizes its prior financial reports
were incorrect). Since 1997, 362. companies monitored by the SEC had
been forced to restate their results, a figure that amounted to nearly I
percent of all filings to the agency. Those restatements had cost
investors dearly. The market capitalizations of nine of those companies
had declined by a total of $41 billion in the week following the restatement. And one of the poster children for bad behavior was Arthur
Andersen.
Andersen, auditor for trash giant Waste Management Inc. for thirty
years, had been caught fudging the numbers. The SEC found that
Andersen had helped the trash company inflate its earnings by more
than $1 billion. In 1998, the company was forced to restate its earnings from I99Z to 1997. Andersen had to pay the trash company an
undisclosed amount of money to settle the dispute. During its investigation of Andersen, the SEC allegedly found that the accounting firm's
consulting fees were five times what it was being paid to audit the
trash company. Furthermore, the SEC alleged that Andersen's audit
team at Waste Management was "cross-selling" consulting services and
that the auditors were sharing in bonuses derived from the consulting
business. The relationship between Andersen and the trash company
was far too close. Almost every chief financial officer and chief
accounting officer at Waste Management had come to the company
from Andersen. The link between the two companies wasn't a revolving door, it was a gravy train.
Although those problems were bad enough, the accounting firm's
problems with Waste Management weren't over. In September 1999,
Andersen and the trash company agreed to settle a spate of shareholder
lawsuits for a total of $220 million. In addition to the Waste Management problems, Andersen's lax approach had caused a series of other
debacles, including a growing controversy over its handling of the
audits of consumer products maker Sunbeam.
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The strength and size of the Big Five was a growing concern to
Levitt for another reason: The SEC's budget was far too small for its
growing workload. Between 1991 and 2000, the number of complaints
and inquiries received by the agency had jumped by 100 percent, but
the SEC's enforcement staff had increased by just 16 percent. During
that same time period, corporate filings increased by nearly 60 percent,
but staff needed to review those filings had increased by just 29 percent.8 Furthermore, the SEC couldn't keep its employees. Between 1998
and zooo, one-third of the agency's staffers quit.
The SEC was being overwhelmed, and that meant the agency had to
have more confidence that corporate filings were honest and reliable.
And the only way to get that was to make sure the Big Five and other
accounting firms were playing fair. Levitt fervently believed in the
motto of one of his predecessors at the SEC, William O. Douglas, who
237
said, "We are the investors' advocates." Douglas also said that the
SEC's enforcement powers were "the shotgun behind the door."
By the time of the SEC commissioners' June 27, 2000, meeting,
Levitt was convinced that the SEC needed more firepower. The other
commissioners readily agreed. And by the end of the meeting at SEC
headquarters, directly across the street from the Supreme Court building in Washington, D.C., Levitt had what he wanted: a unanimous
vote by the commissioners on a rule that Levitt figured would help
assure that the public accounting profession retained its duties to the
public, and not be wholly beholden to the companies that employed
them. The rule even though, with footnotes, it stretched for nearly
60,000 wordswas really quite simple: It said accountants must be
independent. And it set out four instances that would impair an auditor's independence. That independence would be impaired whenever,
during the audit and professional engagement period, the accountant:
"(i) has a mutual or conflicting interest with the audit client, (ii) audits
the accountant's own work, (iii) functions as management or an
employee of the audit client, or (iv) acts as an advocate for the audit
client."9
Levitt didn't know it at the time, but Andersen's relationship with
Enronthe firm's biggest clientviolated every one of those standards.
By the late 19905 Andersen had become so reliant on Enron that it simply could not afford to lose the company as a client. Enron understood
that and used that fact to its advantage. Andersen's revenues from
Enron were enormous. In 1999, the firm billed Enron $46.8 million for
its auditing, consulting, and tax work. In zooo, that figure rose to $52
million.
In addition to the big money, Enron's finance departmentjust like
Waste Management'swas packed with Andersen alumni. The company's ex-treasurer, Jeff McMahon, had worked at Andersen. So had
his replacement, Ben Glisan. So had Enron's chief accounting officer,
Rick Causey. A number of other, lower-level Enron employees, includ-
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239
Derivatives Hocus-Pocus
DERIVATIVES HOCUS-POCUS
241
ate on December 13, 2000. President Bill Clinton signed it into law
eight days later. Gramm hailed the measure, saying it "protects financial institutions from over-regulation" and that it "guarantees that the
United States will maintain its global dominance of financial markets."
Global dominance is always a worthy goal. But Gramm's bill also
contained a provision that congressional aides referred to as the "Enron
exemption." This bit of legislative legerdemain made into law a regulatory exemption on derivatives contracts that was first rushed into place
by the Commodity Futures Trading Commission in 1993. The chair of
that body when the exemption first appeared? Yep, Wendy Gramm.
Why didn't the senator abstain from voting on the matter when it
came before the Senate? In early 2002, a Gramm spokesman told one
reporter that the senator had a policy of "noninterference" when it
came to his wife's affairs. He told another reporter that Phil Gramm
had not written the section of the bill affecting Enron. "We were not
involved with that part of it," croaked a Gramm spokesman.
Therefore, how could it possibly be a conflict? Never mind that in
2001, Enron paid Wendy Gramm a total of $119,292.
Conflict of interest or just the way business is done, Gramm's bill
kept the feds out of Enron's business and allowed Enron to continue
stoking its ballooning financial statements with an ever-larger diet of
derivatives.
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DERIVATIVES HOCUS-POCUS
243
At the end of 1999, Enron had just $5.1 billion in derivatives assets.
Twelve months later, it had $zi billion in assets from derivatives.
The growth of Enron's derivatives business was no more phenomenal than the overall growth of the global derivatives boom. In 1987, the
total value of outstanding derivatives was less than $1 trillion. By the
first half of 2000, the value of all the outstanding financial derivatives
in the United States was over $60 trillion, according to the International Swaps and Derivatives Association.
One of its most innovative products was weather derivatives, an
area that Enron pioneered. The company began selling them in 1997
and found a receptive market. Electric and gas utilities were particularly interested in the offering because it allowed them to hedge the
risks they faced from extreme weather patterns, which are the biggest
variable in the power business. The contracts worked like an insurance
policy that utilities purchased from Enron. If temperatures deviated
from normal temperature ranges during an agreed-upon time period,
Enron would pay the customers to offset their losses. Enron could
package the weather derivatives in a panoply of different ways that
allowed the utilities to protect themselves against weather that was too
cold, too warm, or even too snowy.
Although Enron's derivatives business grew throughout the Skilling
era, EnronOnline and the California electricity crisis caused its derivatives exposure to explode. They also, it appears, helped send the company into bankruptcy.
By trying to manipulate the California energy market, Enron unwittingly made it a whole lot more expensive for the company to keep its
trading business afloat. Enron's moves sent gas prices through the roof.
Electricity prices surged by a factor of eight or more. EnronOnline,
which was already struggling to find enough cash to provide liquidity
in 800 different products, was, with the surging prices in California,
forced to find yet more capital to keep trading. By late 2000 and early
2001, natural gas that was formerly trading for about $3 per thousand
cubic feet in California was selling for as much as $60. Electricity that
was selling for $30 in late 1999 was going for $1,500 a year later. And
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Ken Rice was missing in action, and the executives on the forty-fourth floor of the Enron
building were starting to get worried. Enron's
annual conference with Wall Street analysts at
the Four Seasons Hotel was supposed to begin in less than forty-eight
hours. All of Enron's other business segments were ready with their
conference materials. The lead executives had been briefed, their scripts
had been approved, and each executive had gone over the script.
But Rice, the chairman and CEO of Enron Broadband Services, was
nowhere to be found. He hadn't been in the office for days. That wasn't
unusual. Rice was rarely in the office. Although he was the head of the
broadband division, Rice didn't feel compelled to work overly hard at
establishing Enron's new business. That was fine for him, but his
underlings did have a business to run and they didn't have his millions.
And with the analysts' meeting coming up, they simply had to have
Rice's full attention. Billions of dollars of Enron's market capitalization
were on the line. The broadband executives knew that broadband was
going to be a central part of Jeff Skilling's presentation and that sheets
explaining the broadband division's strategy were going to make up the
bulk of the packets the analysts were going to receive.
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Moreover, Skilling was going to tell the analysts that Enron's stock
was worth $126 per share and that the broadband division alone was
worth $40 of that per-share figure. What would happen if Rice didn't
show for the analysts' meeting? What would happen if Rice did appear
but couldn't handle the presentation? What if he botched the answer to
a question?
The dangers were great, increasing with every passing hour. The
lead executives at Enron Broadband had spent the past several days
looking for Rice. They called his cell phone. They left him voice mail.
But there was no response. Nothing. "We were trying not to tell anybody that we couldn't find Ken," recalled one executive who was at
Enron Broadband during that time. "We started to wonder if he was all
right. Finally, I had to threaten his assistant. I told her, if you don't get
Ken on the line in two hours, I'm going to Skilling."
Twenty minutes later, Rice was on the phone. "Hey, what's going
on?" asked Rice.
"Well, we need you here in the office, the analysts' conference is in
two days," said the executive, who was having difficulty hearing
because of all the background noise on Rice's end of the line. "What's
all that noise? What are you doing?" he asked.
"Oh, I'm out racing my cars," Rice replied.
The executive was floored. He and his coworkers had been putting
in ten-hour days getting ready for the analysts' conference. They had
been fretting over what to say to the analysts. They knew that Enron
Broadband Services wasn't meeting expectations and that the company's broadband strategy was failing. They'd known that for months.
But they had to keep the lid on it. Too much was riding on the analysts'
conference. And now here was Rice, the Accidental CEO, out on a lark,
racing his expensive cars, without a care in the world.
"Well, we need you to come in to the office so we can brief you on
your presentation at the analysts' conference," the executive told Rice.
"Oh, okay."
The next day, Rice appeared at Enron's headquarters and went over
the script for the meeting. After going over the particulars of the script,
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report issued that day. But they pointed out that Enron's profits from
its trading business were falling dramatically. In 1995, the analysts estimated that Enron's profits from its trading businessas measured by
earnings before interest, taxes, depreciation, and amortizationwere
6.5 percent. By 2000, that percentage had fallen to 2.7 percent.1
The Herold analysts blamed Enron's falling profitability on energy
companies like Houston-based El Paso Corporation, Dynegy, and Duke
Energy, all of which had jumped into energy trading to capture some of
the trading business that was being gobbled up by Enron. More important, those companies' trading businesses appeared to be growing faster
and adding more profits to their respective bottom lines than Enron's.
Gagliardi and his peers were "particularly concerned about the sustainability of ENE's [ENE was Enron's trading symbol on the New York
Stock Exchange] above average revenue growth with competitors nipping at their heels."
Enron was not worth the $126 per share that Jeff Skilling had
touted just a few weeks earlier at the analysts' meeting in Houston. Nor
was it worth the $73 per share that it was commanding at that time,
said the Herold analysts. Instead, Enron should be valued at multiples
like those given such New York investment banking houses as Merrill
Lynch and Goldman Sachs. Those firms were trading at fourteen times
their projected 2001 earnings. Enron was trading at forty-four times its
projected earnings. The bottom line: Enron was way overvalued.
Given its falling profitability and the fact that other trading firms
were garnering lower valuations, Enron's stock was actually worth no
more than $53.2.0 per share, they said.
"We admit that Herold remains an 'old economy' valuation fan: we
make no apologies, we like hard assets," wrote Gagliardi and the others. Enron was a "premier energy trader" but, they said, "we suspect its
shares have been levitated by a touch of 'irrational exuberance' in a
perhaps frothy market."
The Herold report was the first time any major Wall Street research
or investment banking firm had dared question Enron's valuation. It
was the first time a major research firm had dared to doubt Enron's
251
story. And it did so at a time when almost every other Wall Street analyst was cheering and Enron was near the peak of its popularity. A Fortune magazine article on Enron would come out nearly two weeks later
raising similar questions, but Gagliardi, Smith, and Parry were the first
analysts willing to stand up and say that Enron deserved more scrutiny
than it was getting.
That meant they were going to hear from Enron. When the phone
call came, it didn't come from the company's senior management or
executive committee. It didn't come from Chief Financial Officer Andy
Fastow or from Chief Executive Officer Jeff Skilling; it came from
Enron's investor relations flack, Mark Koenig.
"He wouldn't talk on the merits of the paper," recalled Gagliardi,
who later tried to engage Koenig in a conversation during a meeting in
New York. "I asked him what was wrong with our report, And he'd
say something like, 'Oh it's just terrible.' They weren't going to engage
us in the facts."
The experience of the John S. Herold analysts was a classic example
of Enron's attitude toward Wall Street: If you can't control them, try to
intimidate them.
The analysts at John S. Herold were able and more important,
were willingto take on Enron because they are truly independent.
Herold doesn't do any investment banking. It's a research-only firm
that sells its reports to fund managers, investment houses, and others. It
doesn't put out buy or sell ratings. Instead, it estimates earnings for various companies and then writes reports that explain those estimates. In
short, Herold has nothing to gain or lose by hyping or panning a specific stock. And for Enron, that meant trouble.
Up until the Herold report was issued, Enron had been able to keep
the Wall Street analysts in line. Virtually every analyst who covered the
company had a buy rating on Enron. That was hardly coincidental.2
"If you ever wanted to do investment banking with Enron, your
analyst had to have a strong buy rating on the stock," said John Olson,
an analyst at Sanders Morris Harris, a boutique investment banking
firm in Houston. "It was borderline extortion." And that extortion was
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255
make sure that everybody in the Enron family was getting full benefits
from all the big banks. So we would coordinate activities with investment banks." Wasden recalled a specific meeting in 1999, where Enron
officials said that in 1998, Enron paid more in fees than any other company in the United States. The numbers from Enron's bankruptcy
appear to bear that out. According to the December 2, 2,001, bankruptcy filing, Enron owed $185 million to two offices of Chase Manhattan Bank, a subsidiary of J.P. Morgan Chase; $74 million to UBS
Warburg; and $71 million to Credit Suisse First Boston. Bear Stearns &
Co. has said it will lose $69 million from the collapse of Enron, and
Commerzbank AG has said it will lose a bit less than $45 million.
The massive fees the banks were being paid by Enron, coupled with
Enron's pressure-packed spin on its story, led to remarkably favorable
coverage from the Wall Street firms that were getting fees from the company. And that coverage continued right up to the time of Enron's bankruptcy. Consider the situation on November 12, 2001. In the previous
four weeks, Enron had announced that it was being investigated by the
SEC. It had fired its CFO, Andy Fastow. It had written off $1.2 billion
in equity stemming from Fastow's creative financing deals, a write-down
that Ken Lay couldn't explain to analysts. It had written off $1.01 billion in bad investments like Azurix and broadband. Every day, the Wall
Street Journal and the New York Times were reporting new, ever more
salacious developments about the Enron saga. Yet the tally sheet among
Wall Street firms included eight analysts with a strong buy, three with a
buy, one with a hold, and one with a strong sell.5
Although Enron's financial statements were difficult to understand,
one part of the company's reports was crystal clear: the cash flow statements. And had the analysts bothered to glance at them, they would
have seen a dreadful record. Sure, Enron was burning through cash, but
a quick review of the cash flow statements during the Skilling era
showed a systemic sickness at Enron: Out of the nineteen quarters that
Skilling was either president or CEO of Enron, the company was cash
flow positive from operations in just six of those quarters. And four of
those six instances occurred in the fourth quarter of the year.
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Something was fishy with Enron's cash flow, and it didn't take a
genius to see it.
But it appears the herd mentality mattered more than hard financial
acumen. "Enron is uniquely positioned to be the GE of the new economy," Donato Eassey, Merrill Lynch's energy stock analyst, told
Bloomberg in February 2,001. "This isn't a management team to bet
against." Eassey resigned from Merrill in December 2,001, shortly after
Enron went bankrupt.6
Enron was the hot stock of 1999 and 2000. To be against the Enron
juggernaut was undoubtedly difficult. And Enron's hard-edged tactics
toward analysts who asked impertinent questions made it easier for the
company to keep the analysts safely corralled. If an analyst asked a
question that Enron's management didn't like, "they'd insult you," said
Holmes. "Basically, they'd say if you are too dumb to understand it,
then why are you here? They could mesmerize the analysts into accepting everything that was said. Some analysts even said they stopped trying to model Enron and they didn't feel bad about it."
The analysts, said Holmes, started to believe that as long as Enron's
earnings per share were increasing, then everything was going to be
fine. But things inside Enron weren't fine. Spending was out of control.
Air Enron
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AIR ENRON
259
one longtime Enron pilot, who lost over $2 million in retirement and
deferred compensation after the company's bankruptcy. Whether the
destination was the Lays' chalet in Aspen or a quick trip to Cabo San
Lucas, Ken and Linda Lay always flew in the newest Falcon 900 in the
Enron fleet. It didn't matter whether a smaller, cheaper plane was available. Nor did it matter whether the Lays were using the plane for personal use. Aviation department officials understood that a Falcon 900
should be available for the Lays at a moment's notice. Sometimes, the
Lays needed two jets: a His and a Hers.
"Several times, Mr. Lay was going to New York, but Mrs. Lay could
not leave at the same time. She'd have something to do, so she'd have
to leave an hour or two later. So we'd fly him to New York and then
follow that plane with another one. Then, the airplanes would have to
deadhead [return empty] back to Houston. It was extravagant. It was a
waste of money. It'd happen eight or more times a year," says one
member of the aviation team. "Here it was Mrs. Lay. We always had to
make something available for her. We had to do everything possible to
accommodate her."
Making the plane available wasn't enough. There were also snacks.
Linda Lay had Ken on a very specific diet. That meant the pilots always
had to make sure that the planes were stocked with specific types of
low-fat cheese imported, of course from France. In addition, the plane
had to be stocked with skim milk and chicken salad for the exclusive
use of the Enron chairman. Linda Lay demanded tuna salad.
The Lay family was constantly finding new and inventive ways of
using the planes as their personal pickup truck. When Robin Lay
moved to France, Ken and Linda wanted to go visit. And since there
seemed to be plenty of room in the Falcon 900, they decided to take
Robin's bed with them. "We were supposed to take a king-size bed, but
we couldn't get the box spring through the door. I said, 'Unless you
want me to cut it in half, it's not going.' So we left it in the hangar. We
ended up taking the mattress and the headboard and the side rails,"
said one pilot who made the trip. A few months later, when Robin
moved back to the United States, the Enron planes were used to carry
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263
area was [pipeline executive] Stan Horton," said the source. "He'd take
a cab. Or he might have a limo pick him up, but nine out of ten times,
he'd take a cab back to the airport. He didn't have a limo driver waiting around for him while he was in his meetings. Instead of a limo, the
pipeline guys would take a couple of cabs back to the airport. They
were also careful on how much catering was ordered for them. They
didn't want to waste anything. The other executives didn't care. They
wanted the best of everything."
The comments about the pipeline guys are revealing. Throughout
the Skilling era, the pipeline business, while always profitable, was
ignored. But pipeline executives are, as a general rule, cheap. They
know that the only way to make money on a long-lived asset like a
pipeline is to cut costs. Rich Kinder was a pipeline guy. And he didn't
like the corporate airplanes. "Every airplane bought during Kinder's era
was bought over his objection," said one high-ranking executive who
worked closely with Kinder. "But the fleet kept growing and growing.
Ken Lay wanted to have the best toys."
During the Kinder era, Enron flew five planes, which included two
Cessna Citations. The Citation is a small, but economical, jet. It can
carry about six passengers at about 400 miles per hour and is a relative
bargain at about $1,500 per flight hour. It's a perfectly functional jet
for trips from Houston to either coast or almost any location within the
United States. Whenever Kinder flew, he always took the smallest airplane available, which usually meant the Citation. And the Citations
were perfect for managing the company's pipelines, which are often
located in remote areas that don't have long, well-maintained airstrips,
places like West Texas and New Mexico, where Enron had significant
businesses. In short, Kinder was cheap, and everyone at Enron appreciated that about him. One source, a female executive who worked at
Enron for nearly two decades, said, "The joke within the company was
'When Rich leaves, let's see how many planes Ken buys.'"
It didn't take long. Within a few weeks of Kinder's departure from
Enron, the company sold the Citations. In their place, Enron bought
two Hawker 8oos, at a cost of about $10 million each. The Hawkers
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are nice airplanes. They are big enough to stand up in. They're
equipped with microwave ovens, coffee makers, a toilet, and big comfortable leather chairs. And to be fair, they are faster than the Citations
and can seat eight passengers instead of six. They also costat $4,200
per hournearly three times as much to operate.
With Kinder gone and the lowly Citations tossed overboard, personal plane use by Enron's executives taxied for takeoff. "Kinder was a
control person, he kept a lid on everything," said one pilot. "When
Skilling took over and the executives found out they could use the
planes for personal use, they went nuts." That meant trips to Cabo San
Lucas for Skilling and his buddies. It also meant frequent trips to
southern Colorado so that Enron executive Lou Pai could visit his
gigantic ranch.
Pai was such a Big Shot that he couldn't be expected to drive to the
airport. You see, Pai lived in Sugar Land, an upscale suburb located
about twenty miles southwest of downtown Houston. Enron's jets were
kept in a hangar at Intercontinental Airport, about twenty miles north
of downtown. So when Pai wanted to visit his Colorado ranch, he
called the Enron aviation department and had one of the Falcon 9005
dispatched to pick him up at the Sugar Land airport. The jet would fly
the forty miles or so from Intercontinental to Sugar Land, a trip that
takes about twenty minutes. "That happened probably ten or twelve
times," said a pilot who worked for Enron for twenty-four years and
flew Pai on many occasions. "And we'd have to do that on both parts
of the round-trip." That means the jet would deadhead for twenty minutes (cost: about $1,700) to Sugar Land, pick up Pai, fly the two hours
to the airport at Alamosa, Colorado (cost: about $10,400), drop Pai
off, and then deadhead back to Houston (cost: another $10,400).
When Pai wanted to return to Houston, the process would be reversed.
Thus, each time Pai visited his ranch on the Enron jet, the company
would incur costs of about $45,000.
But there was a final bit of aerial nuttiness that occurred in Enron's
aviation department. And to fully understand the nuttiness requires a
bit of knowledge of the world of superexpensive aircraft. Among the
AIR ENRON
265
266
PIPE DREAMS
really stretch his legs. The new plane seated sixteen passengers, had two
toilets, a DVD player, a ten-disc CD player, and three eighteen-inch
LCD monitors.
In 2001, Lay justified Enron's fancy fleet by telling a reporter that
"all these planes give my CEOs something to aspire to." The G-V was
Lay's aspiration, the sleek symbol of his success. With the G-V, the son
of a poor Baptist minister was arriving in the highest possible style.
Alas, his ego trips aboard the G-V were few. He took the G-V to
Europe fewer than a dozen times, and most of those were pleasure
trips, including visits to London, Amsterdam, and Venice. Of course, he
took several friends and family members with him when he went on
those trips, including former Enron president Mick Seidl and Harry
Reasoner, a senior partner at Enron's law firm, Vinson & Elkins. And
each time, when Lay and his pals flew back to Houston from their
European adventures, they flew nonstop.
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during the late 19905 and early2000.But Sarofim and his representatives always had the same answer: "We don't understand how they
make money. And we don't buy anything we don't understand."
Ken Lay and Jeff Skilling may have been the princes of Houston's
business community, but they hadn't passed Sarofim's smell test. And
on April 17, 2001, Sarofim's hunch was proven right.
During a conference call with analysts, Jeff Skilling, who'd been
Enron's CEO for just two months, discussed the company's first-quarter results. They appeared impressive. The company's revenues
through the mirage of mark-to-market accountinghad nearly tripled
from the same quarter the previous year, escalating to $50.1 billion.
Trading volumes of gas, electricity, and other commodities had soared.
"First-quarter results were great," Skilling told the analysts. "We are
very optimistic about our new businesses and are confident that our
record of growth is sustainable for many years to come." Skilling then
opened the call to questions and began patiently responding to analysts
who consistently congratulated him on the company's latest numbers.
Then, Richard Grubman got on the line.
The managing director of a $2,.8 billion Boston-based hedge fund
called Highfields Capital Management, Grubman wasn't a typical analyst. He didn't preface his questions with any congratulatory lines, he
didn't work for an investment bank, and he wasn't buying Skilling's
story. Grubman and Highfields were shorting Enron's stock in the
belief that it was going to fall in price.
The Highfields-Harvard University connection is worth mentioning
here. The Highfields hedge fund was founded in 1999 with $500 million of Harvard's endowment money. By mid-zooi, it was managing
some $z billion of Harvard's endowment and was the school's main
private-investment fund. Enron board member Herbert Winokur is a
member of the Harvard Corporation, the university's seven-member
governing body. If Enron's stock price fell as Grubman suspected it
would, then Harvard alma mater to Skilling and Winokurwas
going to make a lot of money.1
Why, Grubman asked, didn't Enron provide the analysts with more
269
information prior to the conference call? Where, for instance, was the
cash flow statement and balance sheet? Skilling responded that Enron
had never provided those reports before analyst calls. Grubman wasn't
satisfied. "You're the only financial institution that can't produce a balance sheet or a cash flow statement with their earnings" prior to conference calls, he said.
"Well, thank you very much," replied Skilling. "We appreciate that.
Asshole."
Skilling's lackeys in the Enron conference room chuckled at their
boss's brazenness. The analysts listening to the call were stunned. Corporate bosses never liked difficult questions, and they didn't like analysts who pushed them too hard. But calling an analyst an asshole?
That just wasn't done. Call him whatever you want in private. Chew
him out when he's in your office. But on the conference call? In front of
all the analyst's peers?
"It was an indication we should have been paying attention and we
should have been pushing hard questions all the way along," said one
Houston-based analyst who was on the call. "It was a form of intimidation, and it was Skilling's message to his long-term shareholders that
he wasn't going to acknowledge those types of pressures, he was going
to keep saying the story was strong and people like that [the short sellers] didn't belong on the call and didn't deserve an answer."
A lot of Houston's old-money crowd, the ones who'd been steered
away from Enron by Fayez Sarofim, were shocked when they heard
about Skilling's comment. They were also relieved that Sarofim hadn't
invested their money in Enron. "It showed that Skilling wasn't ready
for prime time," a member of one of Houston's oldest and wealthiest
families told me. "That marked the beginning of the end."
It was the beginning of the end for Skilling. Although Skilling's
obscenity was deleted from the audio replay of the conference call, the
damage had been done. Several of the major energy publications ran
stories about it. Several members of Enron's Board of Directors were
outraged. Some even called for Skilling to resign. They wouldn't have
to wait long.
It's a good thing George W. Bush has a laissezfaire approach to business. Otherwise, it might
look like he was just trying to help his pals at
Enron.
Although the California energy crisis was raging throughout Bush's
first few months in the White House in 2001, the president refusedfor
nearly six monthsto consider the possibility that the Golden State's
power markets were being manipulated. In some parts of the state, electricity rates had gone from $30 per megawatt hour to an alarming $1,500
per megawatt hour. Rolling blackouts and threats of blackouts
had the state in a near-constant uproar. One of the state's biggest utilities,
Pacific Gas & Electric, went bankrupt, and another, Southern California
Edison, almost did. By the time Bush had spent about 180 days in the
White House, the state of California had spent nearly $8 billion buying
power on the open market just to keep the lights on.
Despite the crisis, Dianne Feinstein, a U.S. senator from California
the largest state in the unioncouldn't get an appointment with Bush.
Maybe it was because she was a Democrat. Maybe it was because Bush
lost California to Al Gore during the election. Whatever the reason, the
271
White House rejected her request for a meeting and even did her the
favor of sending back a form letter that misspelled her name.1
The White House had plenty of time for Enron, though. On April
17, 2.001, Vice President Cheney had a private meeting with Enron
chairman Ken Lay. During the meeting, Lay offered suggestions for
Cheney's energy task force and lobbied Cheney against price caps in
California. Lay even handed Cheney a memo that said, "The administration should reject any attempt to re-regulate wholesale power markets by adopting price caps." Even temporary price restrictions, the Lay
memo said, "will be detrimental to power markets and will discourage
private investment."
Cheney quickly adopted Lay's argument. The day after his meeting
with Lay, Cheney mocked the idea of price caps. He told the Los Angeles Times that caps would only provide "short-term political relief for
the politicians." He also said price restrictions would discourage investment, a matter Cheney called "the basic fundamental problem."2
In late May, Bush visited California and, like Cheney, attacked the
idea that price caps something California governor Gray Davis and
Feinstein had been begging formight help the state restore order to its
electricity system. "Price caps do nothing to reduce demand, and they
do nothing to increase supply," Bush said flatly.
Bush and Cheney were wrong. Enron and several other power companies had been manipulating the California energy market for months
and collecting huge revenues for their efforts. Using strategies with colorful names like Death Star, Get Shorty, Fat Boy, and Ricochet, Enron
had apparently figured out ways to play the state's power system and
drive up prices. Finally, on June 18, 2001, after weeks of rising
intrigue, the Federal Energy Regulatory Commission approved limited
price caps for California. The move quickly settled the state's power
markets.
Of course, Bush didn't just help Enron in California. Bush and
Cheney allowed Enron to write part of the administration's energy task
force plan for America's national energy policy.
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Ken Lay had helped George W. Bush every step of the way during
his journey to the White House. Lay had been one of Bush's first "Pioneers," each of whom pledged to raise $100,000 for Bush. Lay had
made Enron's fleet of airplanes available to the Bush campaign. The
Bush campaign used Enron's jets to fly to different events on eight different occasionsthat's more than any other corporation. During the
2000 election cycle, Lay contributed more than $175,000 to the
Republican National Committee. Enron's total donations to the party
exceeded $1.1 million. Enron gave $250,000 to help fund the Republican Party National Convention in Philadelphia. When the outcome of
the election was in doubt after the polls closed in November 2000, Lay
and his wife, Linda, gave $10,000 to help finance the Bush campaign's
Florida operation during the recount after the election.
After Bush prevailed in the election (thanks to an assist by the U.S.
Supreme Court), Ken and Linda Lay gave another $100,000 to help
finance Bush's inaugural gala. In all, Enron and its top execs kicked in
$300,000 for the inauguration festivities. Naturally enough, the day
after the inauguration, Lay went to a private lunch party at the White
House, where he got to schmooze with the new president one-on-one.
A few weeks later, Lay had dinner with the president. Beyond all that,
Enron's connections in the White House went much further than
George W. Bush. The new president's chief economic adviser, Larry
Lindsey, was on Enron's payroll before going to the White House, earning $100,000 in consulting fees from the Houston company. Marc
Racicot, the former governor of Montana, lobbied for Enron before
Bush named him to lead the Republican National Committee. Robert
Zoellick, Bush's choice for U.S. trade representative, served on an
Enron advisory council. Thomas White, Bush's secretary of the army,
was the vice chairman at Enron Energy Services, a money-losing charade of a company. Nevertheless, when White left Enron, he owned
more than $25 million in the company's stock. Bush's chief strategist
and political guru, Karl Rove, owned more than $100,000 of Enron
stock when Bush took office.
273
With Bush in office and his pals in the White House, Lay was only
too happy to provide them with guidance.
Lay recommended a total of twenty-one people for various federal
posts. Three got the spots Lay asked for. But they were critically important jobs to Enron. Lay was particularly interested in the Federal
Energy Regulatory Commission, or FERC, because that agency regulates the transmission and sale of natural gas in interstate pipelines and
the transmission and wholesaling of electricity on interstate wires
both of which are key parts of Enron's business. Lay recommended that
Bush appoint Pat Wood, the chairman of the Texas Public Utility Commission and a strong proponent of deregulation, to the FERC. Bush
did. Lay also recommended Nora Brownell for the FERC. In fact, Lay
placed a number of phone calls to urge the appointment of Brownell.
Again, Bush did as Lay asked. Lay asked Bush to appoint Glenn L.
McCullough to the chairmanship of the Tennessee Valley Authority, a
powerful agency in the Southeast that operates more than two dozen
hydroelectric dams and other power plants that had a terrible relationship with Enron due to a dispute over huge electricity contracts Enron
did not want to fulfill. Again, Bush did as Lay requested.
Bush's White House provided Lay and Enron with unprecedented
access. In addition to the meeting with Lay, Enron officials met with
Cheney's task force (the National Energy Policy Development Group)
five times and talked with that task force by phone on at least six other
occasions about the measure. Their effort shows.
The National Energy Policy Development Group's final report,
"Reliable, Affordable and Environmentally Sound Energy for America's
Future," released in mid-May of 2001, contains a number of provisions
very favorable to Enron. For instance, the report recommends the creation of a national electricity grid, a move that could allow Enron to
trade electric power more readily in all regions of the country. The
report says permitting for gas pipelines should be expedited.,3 a factor
that would help Enron, already one of the largest pipeline companies in
the world, build more capacity more quickly. The report says America
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PIPE DREAMS
Broadband Blues
276
PIPE DREAMS
The first energy company to plunge into the fiber optic business was
the Tulsa-based pipeline and energy giant, Williams Companies. In
1985, Williams recognized the value of its pipeline routes. The company had some old pipelines that no longer carried oil. Why couldn't
they carry information instead? So the company began stringing fiber
optic cable in some of its old pipelines. The idea was a smash. In 1995,
the company sold its WilTel subsidiary, which had an 11,000-mile fiber
network, to LDDS WorldCom now WorldComfor $2.5 billion in
BROADBAND BLUES
277
cash. By 1998, Williams, through its new subsidiary, Williams Communication, was at it again, building another fiber network.1
Like Williams, Enron got into the fiber optic business almost by
accident. When Enron bought Portland General Electric in 1997, a
small group of people at the utility were building a fiber optic ring
around the city, and they were considering some long-haul fiber projects. Enron executives quickly saw the similarities between telecom and
electricity: Both were commodities that couldn't be stored and had to
be delivered immediately, and both had historically been controlled by
monopolies that were now dealing with a deregulated market. So Enron
began investing tens of millions of dollars in its fiber optic network.
But there were loads of obstacles in Enron's way. Chief among them
was the surfeit of fiber optic capacity. Companies like Level 3, Extant,
Qwest, Broadwing, Global Crossing, and Williams were laying scads of
fiber optic cable, too. Between 1996 and the end of2000,the amount
of installed fiber cable in the United States more than quadrupled,
increasing from 4 million to about 18 million miles. And each of those
companies was eager to carry the same traffic that Enron was targeting.
They, like Enron, believed the Internet revolution would quickly spawn
new demand for high-speed communications. Video-on-demand, Napster, and video conferencing would fill the new glass pipes as soon as
they were installed.
At the same time, as miles and miles of new fiber were being laid in
sewers and along railroads and highways, new technology was allowing each fiber to carry ever-increasing amounts of information. The
process, known as dense wave division multiplexing, uses tunable
lasers that split light into multiple colors, each of which is capable of
carrying an individual signal. Thus, a fiber that was previously capable
of carrying eight high-capacity signals could, with a set of new lasers,
be expanded to carry sixteenor moresignals and do it at relatively
low cost.
In their hubris, Lay, Skilling, and other executives at Enron's broadband unit believed they didn't need to know how the telecom industry
278
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BROADBAND BLUES
279
vices didn't have access to all of the existing fiber networks. Which
leads to the next flaw in Enron's hype machine.
America's natural gas pipelines are interconnected in several locations around the country. So when companies trade gas, they specify
price based on specific delivery points like the Henry Hub on a certain
date. Everyone in the business accepts those places and several others as
standard delivery points. The telecom business has a bare handful of
accepted hubs. Fiber optic networks are idiosyncratic. Each cable of
fiber might have 120 strands of glass in it, each one of which may be
carrying multiple signals of varying capacity. Also, the different fiber
networks don't have common termination points. For instance, in New
York City, the biggest telecom interconnection hub is located at 60
Hudson Street. But there are half a dozen other data centers in the New
York region that are also used by the phone and fiber companies to terminate their networks. In addition, the telecom industry is still grappling with the problem of who will own and operate the switches and
other electronics at the hubs where the carriers' fiber actually intersects.
That lack of easy interconnection means that provisioning a new
circuit between two fiber networks can take weeks, or even months.
Enron tried to surmount this problem by creating "pooling points" that
would act as a Henry Hub in each of two dozen major cities. But the
phone companies like AT&T, Sprint, and WorldCom had little incentive to spend the money required to string fiber cable to those pooling
points for the sole purpose of interconnecting with Enron. Nor could
Enronwhich was already spending hundreds of millions of dollars to
lay fiber across the continentafford to build interconnections with
every major fiber carrier.
Furthermore, the phone companiesthose backward followers of
John D. Rockefellerdidn't see any prospective gain in doing business
with Enron or in allowing Enron to trade their fiber capacity. Doing
business with Enron would let Enron, and everyone else, know how
they were pricing their fiber optic capacity. A transparent pricing market would further erode their already shrinking profit margins.
So what did all of those factors mean for Enron Broadband Ser-
280
PIPE DREAMS
vices? In short, Lay, Skilling, and their cronies were hyping their ability
to trade fiber capacity service that was:
enormously overabundant,
falling in price by 50 percent or more every twelve months,
largely controlled by incumbent phone companies that had no
desire to trade with Enron,
nearly impossible to trade because of security concerns,
not an essential commodity like electricity and gas.
Other than that, Enron's business model was perfect.
Despite the flaws in their business plan, the executives at Enron
Broadband Services could rely on a tool the other telecom companies
didn't have: financial tricks. By spring zooo, the fledgling company
was under great pressure to show revenue growth and fast. So it
turned to an entity owned by Enron's financial-magician-in-residence,
Andy Fastow.
In June 2.000, Enron sold some of its unused in-the-ground fiber
optic cable (called "dark fiber" because it hasn't been connected to
lasers and switching equipment) to LJM2, the partnership run by Andy
Fastow, Enron's chief financial officer. The deal meant $100 million in
revenue to the telecom unit, $30 million in cash, and a $70 million
promissory note from LJM2. Enron's profit on the deal was $67 million, even though prices for dark fiberas well as lit fiberwere
plunging at the time LJM2 did the deal. In June 2000, for an investment of $100 million, an adventurous telecom investor could have purchased about 33,000 miles of dark fiber, nearly twice the 18,000 miles
of fiber that Enron controlled.3 Enron Broadband and Fastow apparently agreed that LJM2 would pay an inflated price for the company's
dark fiber and LJM2 would be made whole later. It appears that's
exactly what happened. Fastow's partnership sold part of the dark fiber
to an unknown third party for $40 million. In December 2000, LJM2
sold the remaining dark fiberdespite a market in which fiber optic
capacity was falling by half or more every six monthsto yet another
BROADBAND BLUES
281
282
PIPE DREAMS
BROADBAND BLUES
283
Ken Lay's trip to India had been nearly useless. He'd spent three days meeting with
Indian officials and hadn't made any progress.
The Indians had stopped paying Enron for the
electricity from Dabhol months earlier. Enron, faced with mounting
losses, had been forced to shut the plant down. Despite Lay's best
efforts, the Indians insisted throughout the negotiations that Enron's
price on the Dabhol power project was simply too high and that the
government could not afford the power from the plant. Despite the bad
negotiations, he and Jeff Skilling were making happy noises to the press
about the state of the Dabhol project. Skilling said Enron's contracts on
the mega-power plant "are very clear. They have very strong provisions, so they will be enforced." Enron has "zero intention of taking
any economic loss on the project. Zero."
The Indians, however, were resolute. After meeting with Lay, Vilasrao Deshmukh, chief minister of the Indian state of Maharashtra, told
reporters that India "cannot afford the cost of Phase Two power and
we do not need all the power from Phase One
We have asked Enron
to slash their tariff." The Indians' refusal to honor the contract was
costing Enron dearly. The last payment the company got for the elec-
285
tricity generated by the plant was in December 2000. The plant hadn't
generated any electricity since May 2,9, when the company decided to
shut it down rather than generate more power at a loss.
Of course, just because Dabhol was failing didn't mean that Enron
officials couldn't make piles of money from the deal. In 2001, Sanjay
Bhatnagar, the CEO of Enron India and a Harvard MBA who served
as Enron's ramrod on the Dabhol project in Indiaexercised stock
options worth $15.4 million.1
As Lay and Skilling sat in Lay's fiftieth-floor office on Friday, July
13, they discussed Dabhol and a long list of other things. As the last
issue wrapped up, Lay assumed they were finished. But Skilling had one
more thing: He was going to resign as CEO.2
Lay was shocked. He thought that Skilling was doing fine. He'd
screwed up badly with the asshole comment in April, but most other
things had gone fairly well. Why quit now? he asked. It was about his
children, Skilling explained. He'd been away a lot and hadn't spent
enough time with them. Pretty soon the teenagers were going to be
going to college and Skilling would have missed his chance. Lay agreed
that family time was important, but that wasn't the only reason, was it?
Skilling hemmed and hawed for a while, then admitted that he wasn't
sleeping. He was worried about Enron's stock price.
The significance of the falling stock price was apparently lost on the
imperial chairman of Enron. But Skilling surely understood it. It had
fallen below $48 in mid-June before staging a small rally. But it was
once again flirting with the $48 level, and Skilling knew that spelled
disaster. Given the fragile nature of the financing behind Andy Fastow's
special-purpose entities, Skilling had good reason to worry about
Enron's sagging stock price. And there were plenty of other reasons for
Skilling's desire to jump ship. First and foremost was the worst cash crisis Enron had ever seen.
By the end of June, the company's cash flow from operations was a
negative $1.3 billion, and the company had been forced to borrow
$1.97 billion just to keep the doors open. Interest costs were soaring,
largely, it appears, due to the cash Enron needed to keep EnronOnline
286
PIPE DREAMS
in business. In the first six months of the year, the company paid $426
million in interest, or more than $2.3 million per day. Short-term and
long-term debt were soaring, too. Between the last day of 2000 and the
end of June 2.001, Enron's short-term debt load more than doubled, rising from $1.67 billion to over $3.45 billion. Long-term debt went from
$8.55 billion to $9.35 billion.
Cash was flying out the door in unprecedented quantities. In the
previous few months, the company had spent $32.5.9 million to buy
back the shares of its failed water company, Azurix. It had spent hundreds of millions more buying paper mills that were turning out to be
almost useless in Enron's trading business. The metals business was
killing the company. In mid-2ooo, Enron paid $446 million for MG,
the huge metals trader. But Enron's losses in the metals business had
already reportedly exceeded $500 million, and the news just kept getting worse. The London Metal Exchange was concluding a long investigation into Enron's trading activities, and it wasn't pleased. About the
same time Skilling and Lay met, the exchange hit Enron with the second-largest fine ever levied against a company for what it called "seriously inadequate" compliance with its trading rules. The exchange's
$264,000 fine against Enron was second only to the multimillion-dollar
penalty levied against a group of banks in the wake of the Sumitomo
Corporation copper trading scandal, in which a rogue trader lost some
$2.6 billion for the Japanese firm. In Enron's case, the exchange said
the company's shoddy work "jeopardized confidence" in the exchange's
delivery mechanism.
The $264,000 fine wasn't a lot of money in Enron's world. But it
was indicative of a bigger problem: Enron's core businesses were in
deep trouble. Aside from the pipelines, which, of course, always made
money, danger signs were everywhere.
Enron Broadband Services, the company that just seven months earlier Skilling said was worth $36 billion, was stinking it up. The day
before, during a conference call with analysts, Skilling told them, "It's
like someone turned off the light switch" in the telecom sector. Enron
had no choice but to cut spending in broadband and hope for better
$100,789
$40,112
$4,779
$1,228
$979
$893
$847
$643
$8,550
$7,151
20,600
17,900
7
18
From 1997 to Feb 2001, ]. Skilling
1996
Revenues
Net Cash from Operating Activities
Net Income as Originally Reported
Net Income Restated 11/08/01
Long-Term Debt
Employees (per Fortune magazine)
Rank on Fortune 500
Revenues
Net Cash from Operating Activities
Net Income as originally reported
Net Income Restated 11/08/01
Long-Term Debt
1999
1995
1998
1997
$31,260
$20,273
$1,640
$501
$703
$105
$590
$9
$7,357
$6,254
17,800
15,555
27
57
was Pres. and COO of Enron*
1994
1993
$13,289
$9,189
$8,984
$7,986
$1,040
$(15)
$460
$468
$520
$584
$438
$333
N/A
N/A
N/A
N/A
$3,300
$3,000
$2,805
$2,600
7,456
6,692
6,955
7,100
94
141
129 svc 500
From 1990 to 1996, Rich Kinder was Pres. and COO of Enron
3q 2001
2q 2001
Iq 2001
$138,718
$(753)
$(644)
$(635)
$6,544**
$100,189
$(1,337)
$404
$409
$9,355
$50,129
$(464)
$425
$442
$9,763
1992
1991
1990
$6,415
$330
$306
N/A
$2,458
7,776
$5,698
$814
$232
N/A
$3,108
7,731
$5,336
$1,081
$202
N/A
$2,982
6,962
*From January 10, 1997 to January 1, 2001 Skilling was Pres. and COO of Enron. He's CEO from February 1, 2001 to August 14, 2001.
** Although Enron's long-term debt in the third quarter of 2001 declined, the company's short-term debt soared. At the end of 2000,
Enron's short-term debt was $1.6 billion. By November of 2001, it was $6.4 billion.
288
PIPE DREAMS
days. The metals trading business wasn't working. Enron was still saddled with the remnants of Azurix, including the British utility, Wessex
Water. Another one of Rebecca Mark's stellar achievements, the international power business, was in similarly poor condition. Enron had
invested about $900 million in Dabhol, and its return was a big fat
zero. And Lay didn't have a clue about how to deal with the Indians.
Despite her faults, Mark had developed personal relationships with the
key players in India. She might have been able to make some headway
on the impasse just as she had after the project was scrapped by the
Indian government in 1996. Or maybe Joe Sutton could have made a
difference. The former army man had worked side by side with Mark
in India and knew everyone, too. But Mark and Sutton were gone.
After repeated clashes with Skilling, they'd cashed out tens of millions
of dollars in stock options and hit the door.
Cash was getting harder to come by. Skilling had already sold everything that wasn't nailed down. In 1999, after months of tense negotiations, Skilling agreed to sell Enron's 5 3-percent ownership stake in its
exploration and production subsidiary, Enron Oil and Gas. And though
that deal gave Skilling about $600 million in cash to play with, it also
stripped Enron of one of its best-run and most reliable businesses. By
getting rid of Enron Oil and Gas, Skilling and Lay had also lost one of
Enron's most experienced and professional executives, Forrest
Hoglund.
Skilling had done all he could by using overseas subsidiaries and tax
tricks. When Skilling took over from Kinder, Enron had just a handful
of subsidiaries, the list of which covered about ten typed pages. By the
end of zooo, Enron had hundreds of subsidiary companies in countries
all over the world. And the list of subsidiaries many of them in tax
havens like the Cayman Islandsnow stretched for fifty-five typed
pages. Skilling had also done plenty of aggressive tax work. In zooo
alone, some $296 million about 30 percentof Enron's profits
reportedly came from aggressive use of tax reduction strategies.3 But it
was likely becoming clear to Skilling that his bag of subsidiary and tax
tricks was nearly empty.
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the Osprey notes required Enron to issue more stock if Enron's stock
fell below $47. (Enron's make-whole obligations in the Whitewing and
Osprey deals are actually derivatives, similiar to the total return swaps
that Enron employed with the Raptors.)
If Enron had to issue stock to prop up the two entities, the additional stock would dilute the holdings of Enron's existing stockholders,
and that would lead to further decreases in the stock price. Wall Street's
love affair with Enron would evaporate. Analysts would downgrade
the stock, and the price would fall further. The downgrades and selling
would feed on each other, meaning Enron's stock would get hammered.
All of the stock options that Skilling had awarded to hundreds of
Enron employeesthe options he'd used to attract them and buy their
loyaltywere going to be worthless.
The financial house of cards that Skilling and Fastow had built in
order to hide debt and pump up Enron's profits was starting to crumble, and Skilling could see it. He wanted out before the shit hit the fan.
In addition to the financial problems, Skilling knew that many of his
buddies were either getting ready to leave or had already left Enron. He
almost certainly knew that his pal Ken Rice was getting ready to leave
Enron Broadband. Rice's heavy stock sales were a clear indicator he
wasn't going to stay. Lou Pai, Skilling's trading genius since his earliest
days at Enron, had already left the company. In fact, Pai's stock sales
had been so heavy prior to his departure on May 18, 2001, he sold
300,000 shares in one daythat both Lay and Skilling had asked him
to be more moderate. Pai had refused, of course, and ended up selling
$Z7O.z million in stock before leaving.
Cliff Baxter, another Skilling crony, was gone, too. And like Pai, he
left with his pockets stuffed full of cash. Baxter, who served a brief
stint as Enron's vice chairman, sold $34.7 million in stock before leaving Enron.
Although Skilling's resignation wouldn't be made official until
August 14, it appeared Lay was already hedging his bets, too. Lay had
been selling his Enron stock on a regular basis throughout 2001. In the
two weeks prior to his meeting with Skilling, Lay sold 31,500 shares of
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Enron stock. On July 13, he sold another 3,500 shares of Enron stock
and pocketed $104,750 for his trouble. Lay continued selling 3,500
shares a day for the next few days. On July 20, he sold a total of
78,500 shares for a one-day gain of over $2..1 million.
Like Ken Rice and Jeff Skilling, Ken Lay was also bailing out. And
even though he'd never heard of a woman named Sherron Watkins, she
was about to become a major player in his life.
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tainty, and this has added a level of uncertainty," stock analyst Andre
Meade told Bloomberg.1 The surprise announcement punished Enron's
stock. When news of Skilling's departure hit the stock market, the company's stock fell by more than 6 percent. Since the time Skilling became
CEO in February 2.001, Enron's stock had fallen by nearly half.
Rumors were flying. One prominent rumor said Shell Oil had been
planning to buy Enron. The two sides had talked for weeks, but Shell
was scared off by Enron's impenetrable accounting. The rumors, combined with Skilling's announcement, just added more selling pressure to
Enron's stock, which was already being hammered with questions
about Dabhol and the company's apparent involvement in price gouging in California's electricity markets.
Sherron Watkins didn't believe any of Skilling's explanations. And
she was going to do something about it. An eight-year veteran of
Enron, Watkins was typical Enron: smart, aggressive, and not timid
about speaking her mind. That characteristic hadn't won her a lot of
friends. At the same time, there was no doubting her guts. If she had
questions about the weird accounting that she was seeing as a member
of Andy Fastow's financial group, she was going to bring them up to
whomever she pleased. And Watkins knew the only person who could
address her questions was Ken Lay. She also knew that as soon as she
spoke out about Enron's accounting mess, she was going to catch hell.
Watkins's boss, Andy Fastow, was going to be livid. Fastow controlled
people like Watkins through fear. His volcanic temper and intimidating
tactics had allowed him to quell any dissent at Enron. But Watkins was
running out of choices. She'd been given the opportunity to peer behind
the curtain at Enron's finances, and she didn't like what she saw. The offthe-balance-sheet shenanigans that Fastow had been up to were eventually going to kill Enron if something wasn't done about it. So the day
after Skilling quit, Watkins sent Lay an anonymous one-page letter.
In her memo, she told Lay that Skilling might be "resigning for 'personal reasons,' but I think he wasn't having fun, looked down the road
and knew this stuff was unfixable and would rather abandon ship now
than resign in shame in two years." She also discussed Fastow's most
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also worked with her at Andersen. In 1993, McMahon, who was one
of MG's internal auditors, warned his superiors that poor internal controls could cause problems for the company. McMahon's warnings
went unheeded. Like Watkins, McMahon left MG after it fell apart and
went to work at Enron. And the two became good friends.
At Enron, Watkins worked on some of the original off-the-balancesheet partnerships, including the Joint Energy Development Investment
Limited Partnership, or JEDI. She then went to work in Enron's international business for several years before landing at Enron Broadband
Services in early zooo.
It was at the broadband division where Watkins made a number of
enemies. One former coworker in that enterprise called Watkins a
"conniving, manipulative self-promoter to a dangerous extreme. She
was poison in the well. She brought down people and deals to try to
make herself look the hero," said the source. Several others from the
same unit question why, given Watkins's knowledge of all the fraud and
mismanagement at Enron Broadband Services, she didn't mention any
of those things in her letters to Lay.
When Watkins's letter was made public, many people at Enron
began speculating that her memo was an effort to ally herself closely
with Jeff McMahon, who'd spent about two years as Enron's treasurer.
Like Watkins, McMahon didn't like Fastow or his off-the-balance-sheet
deals. In March 2000, McMahon had gone to Skilling to complain
about the many conflicts of interest inherent in the LJM partnerships
being run by Fastow. Rather than address the problem head on, Skilling
offered McMahon a job as the chief executive officer of another Enron
company, Enron Industrial Markets. McMahon took the job, and the
LJM matter disappeared. As one source explained it, "McMahon's
future was over at Enron. By going to Skilling, he'd laid out his cards
saying 'This place stinks.'"
Watkins may have been hoping that her letter would force Lay to
deal with the off-the-balance-sheet problems and perhaps even get rid
of Fastow. That would leave the position of chief financial officer open.
And that meant either McMahon, or perhaps even Watkins herself,
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could move up into Fastow's old spot. Either way, Watkins would be
protected.
Whatever her motives for writing the letter, they were effective.
Watkins was able to mark herself as a whistle-blower without really
going public. By writing the letter, she protected herself from getting
fired. That move was certainly good insurance for her position at
Enron, but it was also clear that her letter was having repercussions
inside the company.
Predictably, Andy Fastow was enraged when he heard that Watkins
had talked to Lay. One source close to the matter said that shortly after
Fastow heard about Watkins's memo and her subsequent meeting with
Ken Lay in his office, Fastow stormed into Watkins's work area and
told her immediate supervisor, "I want that bitch [Watkins] out of here
tonight." Fastow then went into Watkins's office and ripped her company-issued laptop off her desk. "Fastow took the laptop and threw it
in his closet in his office," recalled the source. "He thought that would
take care of the memo problem. But Fastow's such a dope he doesn't
know that everything is backed up on the network."
The other almost immediate reaction caused by Watkins's memo
was a half-hearted effort by Ken Lay to investigate the matters she had
raised. Although Watkins's memo advised Lay to hire a law firm other
than Vinson & Elkins to examine the partnerships, Lay ignored her
advice. He promptly contacted Enron's longtime law firm and asked it
to look into the issues Watkins was raising. A few weeks later, the law
firm assured Lay that the off-the-balance-sheet matters were not a
problem. That wasn't a surprise; Vinson &C Elkins had helped Enron set
up many of the partnerships.
Like Arthur Andersen, Vinson & Elkins one of the biggest and
most prestigious law firms in Texaswas a captive of Enron. In zooi,
Enron paid the firm $30 million for its services, a figure that amounted
to about 7 percent of the firm's total billings. Many of its alumni,
including Enron's general counsel, James Derrick, went on to work at
Enron. Clearly, Vinson & Elkins was the wrong firm to investigate Fastow's partnerships.
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But Ken Lay apparently didn't consider the law firm's conflicts of
interest. It would prove to be one of the many poor management moves
he would make as his firm sprinted toward bankruptcy.
Meanwhile, Watkins was looking out for her financial interests. She
sold $31,000 worth of Enron stock in late August. She went on to sell
another $17,000 block of stock options in early Octoberprobably a
good move on Watkins's part. And whatever she took out of Enron was
a pittance compared to Ken Lay's plunder.
On August 21, the day before he met with Watkins and got her
memo about the accounting problems, Lay wrote an e-mail to all of the
company's employees. "As I mentioned at the [August 16] employee
meeting, one of my highest priorities is to restore investor confidence in
Enron
This should result in a significantly higher stock price." Perhaps it's just coincidence, but that same day, August 21, Lay sold
68,620 shares of Enron stock, netting himself just over $i million. The
day before that, Lay had sold 25,000 shares, taking home nearly
$387,000.
Lay was cashing out while he could. And although Enron was getting shaky, Lay still had a few cards to play. The Dabhol project in
India was a major problem. But he had some friends in Washington,
friends who owed him a favor or two.
George W. Bush was Enron's defender in California. In India, he was the company's bill collector.
Since the Indian government wasn't going
to pay Enron the money it owed the company for the Dabhol power
plant, the Bush administration was going to have to do some arm-twisting. If it didn't, American taxpayers were going to be on the hook for
hundreds of millions of dollars. Two federally backed agencies, the
Overseas Private Investment Corporation, which provided a total of
$391.8 million in insurance on the project, and the Export-Import
Bank, which provided $302. million in loans,1 had backed Enron's Dabhol project, and by summer 2.001, it was looking like their entire investment was going to be lost.
So the Bush administration made Dabhol one of its highest priorities. Beginning in June 2001, officials within the National Security
Council began directing an effort to coerce the Indian government to
make good on its deal with Enron. Governments are always looking
out for the business interests of their corporations, particularly wellconnected companies that provide big campaign contributions. But the
Bush administration's interventions on behalf of Enron are remarkable
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SEPTEMBER 4, 2001
Enron closing price: $35.00
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record amount for his work sold at auction.1 The committee also
bought works by sculptor Donald Judd, painter-printmaker Vic Muniz,
video artist Nam June Paik, photographer Julie Moos, and painter
Bridget Riley.
In July and August zooi, Lea Fastow oversaw the installation of
several of the newly purchased art pieces in the new building, including
several by Muniz. "[One of them] was nine or ten feet high," said a
source. "It cost about $110,000, and there were half a dozen of those."
But the piece ended up in a hallway, said the source, where viewers
couldn't get far enough away to get an overall impression.
There was a giant green glass globe that was designed specifically
for the lobby of the new building that reportedly cost the company
some $z million. Lea Fastow was also heading projects involving a
lighting installation that would link the two buildings that was to be
created by Danish modernist Olafur Eliasson. There was going to be an
installation on one of the trading floors by video artist Bill Viola. Company insiders say that while Lea Fastow was acting out her role as art
princess in Houston, Andy Fastow was reportedly buying art for Enron
offices in other parts of the country, including an office in Denver.
Conserving money was not a concern. And Lea Fastow relied on
Enron to cover her art-related expenses. Those expenses were usually
fairly small. But according to a source close to the art-buying committee, Mrs. Fastow also billed Enron for her limousine use. On December
8, 2.000, her limousine costs totaled $832..46. She used a limousine
again the following night that cost Enron $456.30. But the real fun was
had during a trip Lea Fastow took to New York City aboard one of the
company's planes. On March 13, 2001, according to the source, she
and one or two other members of the art committee went on an artbuying trip. Their total bill for food and lodging during their stay in the
Big Apple: $14,168.41.
The art-buying binge on Enron's behalf paralleled the Fastows' own
efforts to become movers and shakers in the Houston art scene. They
bought a number of modern art pieces for themselves, including a
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or the existing assets," said one internal auditor. "Enron didn't even
know what was ordered because it was all done by Lea Fastow. She
was buying art all over the place. The purchase orders were done by
her. The shipping was handled by her. And everyone in the building
deferred to her."
Although few people knew it at the time, there was plenty of reason
for the Fastows to be in a hurry. Andy Fastow's lucrative run on the
Enron teat was about to run out.
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ured Wall Street would go bonkers if Enron fired Andy Fastow right
away. Maybe they just didn't know what to do.
There had been inklings of Fastow's partnerships in the previous few
days and Enron had acknowledged taking losses on them, but no one
from the company was saying anything. Enron's PR flacks refused to
talk to the Journal. So did Fastow. So did Michael Kopper, Fastow's pal,
who quit Enron in order to buy out Fastow's interest in LJM2 in July
2.ooi.2 The company's inaction, coupled with its silence were once
againdriving the stock price down. On October 19, Enron's stock
closed at $26.05, a decline of 10 percent from the price a day earlier.
Everybody wanted to know more about Fastow's payouts. The
October 19 story followed an earlier Journal story, on October 17,
which reported that Fastow had made $4.6 million from his stock
options at Enron. The short sellers were coming out in force, and if
Enron had been cooking the books, then the stock was going to fall further and that meant an opportunity to make money.
Also, the Wall Street guys were still asking questions about the
events of October 16. That day, Ken Lay had stunned Wall Street by
announcing that Enron was losing money, lots of money. For the third
quarter of 2001, Enron announced it had lost $618 million. It was the
company's first quarterly loss since 1997. The loss was primarily
caused by the company's decision to write off $1.01 billion in bad
investments. That total included a $544-million loss on investments in
New Power, various broadband businesses, and several technology
companies. There was a $287-million charge for lousy assets associated
with Rebecca Mark's misadventures at Azurix and a $i8o-million
charge to restructure Enron Broadband Services. Finally, there was a
$35-million charge that piqued everyone's interest: It was for bad deals
Enron had done with Fastow's LJM2.
There was more. Lay stunned the Wall Street analysts when he
causally dropped another bombshell: Enron was taking a $i.z-billion
reduction in shareholder equity.
The Raptors had come home to roost.
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Beginning in August 2001 and continuing into October, the accountants at Andersen and Enron were realizing that the Raptors were
totally insolvent. It appears that several Andersen auditors were reaching that conclusion at about the same time they got an e-mail from
Enron's head of research, Vince Kaminski.
An average-size man of seemingly boundless energy, Kaminski could
as easily discuss French literature (in French) as complex mathematical
models for future commodity prices. A polymath and polyglot, Kaminski started working at Enron in 1992. A native of Poland, he had three
degrees, a Master of Science in international economics and a Ph.D. in
mathematical economics from the Main School of Planning and Statistics in Warsaw and an MBA from Fordham University. In addition to
being smart, Kaminski had the added virtue of being honest, a factor
that quickly put him at odds with Andy Fastow.
In 1999, Kaminski, the company's head of research, had objected to
the very first deal that Fastow had done with LJM1. Two years later,
his opinion of Fastow hadn't changed. On October 2, Kaminski sent an
e-mail to an accountant at Arthur Andersen to alert the firm about the
problems Enron faced with the Raptors. About the same time, Kaminski also notified Enron's chief risk officer, Rick Buy, that he and the
people in his research group would no longer do any work on any of
the LJM or Raptor transactions, even if it meant he would be fired.
Kaminski's stand, coupled with the ongoing decline in Enron's share
price and the drop in the stock prices of Avici and New Power, left Enron
with virtually no choice: It had to "unwind" the Raptor deals. And in
doing so, the company would have to correct the blunder Enron's
accountants had made in their initial accounting for the Raptors.
In mid-2000, when Fastow's LJM2 set up the Raptors, Enron
pledged 55 million shares of its own stock, worth about $1 billion, to
off-the-balance-sheet entities. The Raptors used the stock as capital to
hedge against the possible decline in value of the Avici and New Power
stocks. In exchange for the loan of Enron stock, the Raptors gave
Enron a promissory note pledging to repay the $1 billion. But in
accounting for the promissory note, Enron's finance team made the
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Enron, Lay wanted to have LeMaistre and Duncan's report. Then he'd
know how best to handle the Fastow matter.
Second, the Securities and Exchange Commission was snooping
around. On October 2.2., Enron announced the SEC had begun looking
into Enron's dealings with Fastow. The news killed Enron's stock again.
By the end of trading on October 2.2, Enron's stock had fallen 2.1 percent, closing at $20.65.
Finally, the class-action lawyers were closing in. That same day,
October 22, Milberg Weiss Bershad Hynes & Lerachthe mega-law
firm that corporate Big Shots love to hate had filed suit against
Enron, alleging that Lay, Fastow, and other Enron insiders had failed to
disclose material information to the company's shareholders.
Of all the issues Lay was facing, the lawsuit had to be among the
most worrisome. Milberg Weiss was one of the most aggressive law
firms in the business. Its lawyers had made tens of millions of dollars
suing companies like Enron for alleged breaches of securities laws.
There was even a term for getting sued by the firm, it was called "getting Lerached" a phrase that referred to the no-holds-barred tactics of
Milberg's lead attack-dog litigator, Bill Lerach. One CEO who decried
Lerach and his tactics called him "lower than pond scum." Now that
he was a defendant in a lawsuit, Ken Lay must have known that everything he would say or do would be parsed and scrutinized by Mr. Pond
Scum and his pack of lawyers. And with Milberg leading the way, a
school of other feeder sharks was certain to follow, eager to snack on
Enron's faltering business.
The same day that Milberg Weiss sued Enron, Lay held a meeting
with sixty of Enron's highest-ranking employees, the managing directors. In a meeting at a conference room at the Hyatt Regency, just
across the street from Enron's headquarters, Lay tried to reassure the
directors that everything was going to be fine and that he had confidence in Fastow. "Ken said, 'We support Andy. We don't think he's
done anything wrong,'" recalled one Enron official who attended the
meeting. Lay also insisted there was nothing wrong with the deals that
Enron had done with Fastow.
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Lay's sales pitch didn't work. Many of the managing directors were
"saying Andy needs to go," according to one official who attended the
meeting. The most vocal member of that group was Kaminski. During
the open-floor segment of the meeting, Kaminski told Lay and the other
directors that Enron needed to reveal all of its deals with Fastow, deals
that he called "terminally stupid" and "improper." Kaminski was so
inflamed about Fastow's flimflams and complained about them for so
long, that Enron's new president, Greg Whalley, finally had to ask him
to stop. Many of the managing directors agreed with Kaminski.
Although they didn't know very much about the off-the-balance-sheet
deals with Fastow, the general feeling was that Enron needed to make a
bold move, expose the problems, and move on.
Lay was adrift and wasn't sure what he should do. He "didn't have
anybody who he could trust," said one source close to the situation.
After Skilling's departure, he had appointed Whalley and a new vice
chairman, Mark Frevert. Both men were fairly capable, but they had
virtually no high-level management experience. Beyond that, Enron
insiders said Frevert had planned to leave Enron shortly after Jeff
Skilling resigned, but Lay imposed on him to stay. Frevert didn't need
to stay. In 2001, Frevert got cash payments from Enron that totaled
$17.2. million. According to Enron bankruptcy documents, that sum
includes an amazing $7.4 million in income from what Enron calls
"Other." The filing defines "Other" as relocation costs, severance
costs, consulting, and income imputed due to use of corporate aircraft.2
That amount was in addition to his stock sales, a mere $54.8 million.
Only Ken Lay surpassed Frevert in the final playoff of the Enron
Greed Bowl. In xooi, Lay's cash payments from Enron totaled $103.5
million.3
Worse yet, Whalley and Frevert had only been in their positions
since late August. Lay didn't really know them that well. "Whalley and
Frevert were new. There was nobody Ken could call for the unvarnished truth or even an unvarnished perspective," said one Enron managing director. "Ken was on his own."
Whether it was bad advice or his own vanity, Ken Lay just couldn't
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keep quiet. And Enron scheduled another conference call with Wall
Street analysts for the morning of October 2,3.
When the call began, Laywho, according to a source close to the
situation, insisted on handling the script for the call himselfonce
again defended Fastow. He insisted that Fastow's partnerships had been
fully disclosed to investors and that the board had taken measures to
insure that no conflicts existed with Fastow's dual roles inside the company. He said that Enron had constructed a "Chinese wall" between
the company and Fastow's partnerships and that deals were only done
when they were "in Enron's best interest." Lay acknowledged the interest in the Fastow matter, saying, "We know there are a lot of rumors
getting out, a lot of speculation. It's done a lot of damage to us over the
last few days. We want to get the facts out."
The analysts weren't convinced. David Fleischer, an analyst at Goldman Sachs and one of Enron's biggest cheerleaders, told Lay, "What
you are hearing from many is that the company's credibility is being
questioned and there is a need for disclosure. . . . There is an appearance that you are hiding something."
Lay was still in defend-Andy-Fastow mode. He responded, "Obviously, the board and even the lawyers and auditors realized that there
would be an apparent conflict of interest there and the board prescribed certain methods for it to be dealt with, so Enron would never
be compromised. We are very concerned the way Andy's character has
been loosely thrown about in certain articles, as well as the company's
reputation."
Lay should have stopped there. He didn't. "I and Enron's Board of
Directors continue to have the highest faith and confidence in Andy
and think he's doing an outstanding job as CFO," Lay said.
The defense of Fastow should have been enough fireworks for one conference call. But the analysts wanted more details about other financial
land mines that Enron was facing: Whitewing, Osprey, and Marlin.
Enron had used the off-the-balance-sheet entities to buy some of its
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Ken Lay was hiding something from the analysts. The same day as the analysts' conference
call, Lay apparently heard back from his fellow Enron board members, LeMaistre and
Duncan. The two men had finally talked to Andy Fastow. They'd asked
the CFO how much money he'd made from LJM1 and LJM2. When
they heard the answer, they could barely believe it.
Fastow told the two men he'd made an astounding total of $45 million from LJM1 and LJM2. Fastow, the man who had a fiduciary duty
to Enron's shareholders, told the board members he'd invested $i million in LJM1 and $3.9 million in LJM2. For that investment, in less
than two years, he'd made $Z3 million from LJM1 and another $zz
million from LJM2.1
That was hardly Fastow's only source of income. Over the previous
three years or so, Fastow had sold 687,445 shares of Enron stock, with
total proceeds of $33.67 million. And Fastow didn't stop: On August
16, 2001, he had actually bought another 10,000 shares of Enron
stockperhaps he thought it was a good investment. There was more.
Back in January and February 2001, Fastow, along with other top
Enron executives, had received huge bonus payments that were based
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in large part, on the amount of Enron's profits. Fastow's total take from
the bonuses: more than $3 million. All that cash was, of course, in
addition to Fastow's annual salary of $440,698.2 So, in other words,
Fastow was dunning Enron four different ways. He was: (1) on the
Enron payroll, (2) making money from the LJM1 and LJM2 deals,
which never lost money on their dealings with Enron, (3) cashing in
stock options that were more valuable because his LJM1 and LJM2
shenanigans helped artificially inflate the price, and (4) getting a cash
bonus from Enron because the stock was doing so well.
Nice work if you can get it. The other side of the story is that while
Fastow was getting rich, Enron's employees were getting poor. On
October 17, Enron froze all of the assets in the Enron Corp. Savings
Plan. The company said it was freezing the assets because it was changing the administrators of the retirement plan. That may have been the
case, but by freezing the assets, the company also prevented Enron
employees from selling their Enron holdings as the shares plummeted.
At the end of 2000, the Enron Corp. Savings Plan contained $2.1 billion in assets, and 6z percent of that total was invested in Enron stock.
By the time the asset freeze ended on November 19, the value of
Enron's stock had fallen from $32.20 to $9.06, and thousands of the
company's employees had lost the bulk of their life savings.
Lay didn't deign to tell anybody on Wall Street that Fastow had
made such an incredible fortune at Enron. In fact, Lay and his cronies
on the Enron board kept Fastow's $45-million windfall from LJM1 and
LJM2 as their own dirty little secret until May 2002, when LeMaistre
finally revealed the figure during his testimony before the U.S. Senate.
Lay didn't have a conference call to announce his next move.
Instead, on the afternoon of October Z4, Enron issued a terse, six-paragraph press release saying that Fastow's rival, Jeff McMahon, would be
the company's new chief financial officer. "Andrew Fastow, previously
Enron's CFO, will be on a leave of absence from the company," said
the release. "In my continued discussions with the financial community," Lay said, "it became clear to me that restoring investor confidence would require us to replace Andy as CFO."
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That day, Enron's stock closed at $16.41, down more than $3 from
the day before. Lay was clueless about what to do next. His company
was falling apart. The problems with Whitewing, Marlin, and other
plunging-in-value assets like Dabhol and broadband were leading a
handful of Wall Street watchers to compare Enron's collapsing fortunes
to the 1998 failure of the giant hedge fund Long-Term Capital Management. Like Long-Term Capital Management, which was led by a group
of cocky, self-absorbed traders and Nobel Prize-winners, Enron's arrogance was now costing it dearly.
On October 2.4, the same day Fastow was put on "leave of
absence," Peter Eavis, a sharp-eyed columnist at TheStreet.com, who'd
been crying bullshit on Enron's story for months, wrote, "Lay has
shown himself to be woefully out of touch with the market's views.
Arguably, that's downright reckless for a trading company that is
dependent on potentially skittish short-term financing." Eavis added
that Lay was showing "an unhealthy reluctance to address key problems until they're unavoidable... is it any wonder people compare this
lot to Long-Term Capital Management?"4
Five days after Eavis's column appeared, Moody's cut Enron's credit
rating to two notches above junk status. Enron's stock fell again, to
$13.81. If Moody's and the other credit agencies were to cut Enron's
debt to junk status, it could force the company to pay off billions of
dollars in debt early, compelling it to issue tens of millions of new
shares to cover the debt. The new shares would dilute the existing ones,
reducing their value even further.
The destruction of Long-Term Capital Management had taken just
five weeks. Enron's fall, it appeared, might happen even more quickly.
Ken Lay was going to have to take drastic action. It was either
merge or go bankrupt. He had to try a merger, and by early November,
Dynegy, Enron's longtime rival, was the only company interested
enoughor able topull off a merger.
So where was Jeff Skilling during the crisis? Enjoying his cash.
Posh PJ's
NOVEMBER 2, 2001
Emon closing price: $u.30
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from the $14.5 million makeover of the former Red Lion Hotel,"
reported the Chronicle's Shelby Hodge.1
The paper didn't report a cost for the event or whether party goers
had to pay to attend. Whatever the charges, Jeff Skilling could afford it.
On August 15, the day after he announced that he was resigning from
Enron, Skilling sold 140,000 shares of Enron stock. The sale was
reported to the Securities and Exchange Commission as a "planned
sale." Skilling's proceeds from the sale: $7.9 million. The sale brought
Skilling's total stock sales to $70.6 million. Of course, that wasn't the
only money Skilling made from Enron in 2001. He also got a salary of
$1.1 million, a bonus of $5.6 million, and incentive pay of $1.9, for a
total of $8.6 million.2
Jeff Skilling was living a wickedly stylish life. Ken Lay was sweating
bullets.
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lic Policy Enron Prize for Distinguished Public Service allowed Lay to
cement his ties to the Bush family's consigliere and Enron's former lobbyist, James A. Baker III.
Better still, the Enron Prize allowed Lay to become something of a
statesman. It gave him a way to take the stage next to Baker, the former
secretary of state, and pontificate on world politics while rewarding
such Bush family allies as Colin Powell (who got the Enron Prize in
1995) and such global leaders as former Soviet Union president
Mikhail Gorbachev (1997). The dinners and cocktail parties that came
with the prize provided Lay with an additional opportunity to chat
with people who could advance Enron's international projects. When
Lay and Baker gave the Enron Prize to Mandela, Lay got some facetime with Prince Bandar bin Sultan, the Saudi Arabian ambassador to
the United States. With the Gorbachev award, Lay got to chat up uberexecucrat Henry Kissinger.
The November 13, 2001, event at the Rice University campus in
central Houston was not much different from previous Enron Prize
award ceremonies. Federal Reserve chairman Alan Greenspan certainly
fit the Friend-of-the-Bushes profile, and he was clearly high-profile.
And like the other awards, Lay almost surely had an ulterior motive.
Indeed he did. In late October, Lay had called the president of the
Federal Reserve Bank of Dallas, Robert McTeer, to discuss Enron's
worsening condition. (Incidentally, Jeff Skilling was a member of the
Houston branch of the Dallas Fed from February 2000 to January
2,002.. In December 2000, Skilling had given a presentation on Enron to
Fed chairman Alan Greenspan and members of the Fed's Dallas
branch.1) On October 26, Lay called Greenspan himself. Although the
call was reportedly brief, it must have been obvious to Greenspan that
Lay was hoping that he might help engineer the same type of bailout
for Enron that the Federal Reserve had for Long-Term Capital Management, in 1998. As it teetered on the edge of collapse, Long-Term had
only about $1 billion in cash to cover its losses. Yet through very heavy
borrowing, it had amassed $100 billion in assets and a derivatives position with a notional value of $1 trillion.2 If the Federal Reserve System
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anyone else at the federal level, would help his company. In fact, on
October 2.8, two days after he called Greenspan, Lay called Treasury
Secretary Paul O'Neill and compared Enron's problems directly to
those of Long-Term Capital Management. O'Neill, according to the
White House's version of the events, then instructed Peter Fisher, the
deputy treasury secretary, to talk to Enron officials about their predicament. Fisher was also to assess how the possible failure of Enron would
affect the overall American financial market.
By the time Greenspan got to Houston, it was clear that both Lay
and his company were in desperate straits. Dynegy was going to buy
Enron for about $9 billion in stock, and John Henry Kirby's company
would disappear forever. The company would be called Dynegy. There
was no job for Ken Lay. Dynegy's CEO and chairman, Chuck Watson,
would be the boss, and his peopleSteve Bergstrom, who was Dynegy's president, and Rob Doty, its chief financial officerwould keep
their spots in the new company. Dynegy would have eleven of the fourteen seats on the new board. Enron could have three.
Whatever was going to happen to Enron, it was likely that
Greenspana committed free-marketeerrealized that he couldn't
help the company even if he wanted to. So the bespectacled chairman of
the Federal Reserve did what he was invited to do: In his plodding,
drier-than-sand style, he delivered a speech that was desperately unremarkable. The speech, which featured a recitation of world energy supplies and prices, lasted about ten minutes and contained such hilarious
lines as "The long-term marginal cost of extraction presumably anchors
the long-term equilibrium price and, thus, is critical to an evaluation of
the magnitude and persistence of any current price disturbance."4
Greenspan's only remarkable comments came during a questionand-answer session afterward. When asked about his advice for people
now entering the job market, he said, "I do not deny that there are
innumerable people who succeed in business by being less than wholly
ethical. But I will say to you that those are the rare examples; the best
chance you have of making a big success in this world is to decide from
square one that you're going to do it ethically."5
327
In all of his remarks, Greenspan didn't mention Enron once. But his
prescription for business successalong with his refusal, apparently for
reasons of propriety, to accept any Enron lucrelikely made Ken Lay
wince. When Greenspan flew out of Houston, the only thing he took
back to Washington was the nice certificate that came with the Enron
Prize. Greenspan left behind both the lovely crystal trophy that came
with the Enron Prize and the checkthe amount of which Rice has
kept a closely guarded secretthat went with it.6 Enron had purchased
senators, governors, lobbyists, secretaries of state, and a few presidents.
It could not buy Andrea Mitchell's circumspect husband.
By the time Greenspan left Houston, Ken Lay was probably wishing
he could take the cash that came with the Enron Prize back to 1400
Smith. He needed it. Enron wasonce againin a cash crisis. This one
would be fatal.
NOVEMBER 19,2001
329
the dealsit was actually in excess of $45 million, but what's $15 million among friends? In the effort to clean up the mess and regain a
modicum of credibility, the company also announced it had fired Enron
treasurer Ben Glisan and Broadband Services lawyer Kristina Mordaunt, both of whom had made an ever-so-easy $i million by investing
in Fastow's Southampton partnership deal.
Although the November 8 restatement was bad, it wasn't fatal. In
fact, Wall Street kind of liked it. That's because it was accompanied by
news that Dynegy, Enron's rival, was going to buy the company. In the
week after the restatement, Enron's stock actually rose in price, breaking a long downward trend. By November 14, Enron closed at $10 a
share, its highest level since November 5. Enron's suddenly stable stock
price gave some analysts and more than a few people at Enron and
Dynegy hope that the merger might actually work.
Then came the November 19 restatement.
Enron was coming apart far faster than anyone had imagined. The
November 19 filing with the Securities and Exchange Commission
showed that Enron was restating its third-quarter financial results for
the second time in eleven days. When the company filed its original lo-Q
(the quarterly financial statement that public companies must file with
the SEC) on October 16, it said it lost $618 million in the third quarter
of 2001. On November 8, it said the third-quarter loss was $635 million. On November 19, it said the loss was actually $664 million.
As disturbing as that information was, it was a fairly minor matter
compared to the grenades Enron buried in a section called "Recent
Events." Enron said that the November 12 downgrade of its debt by
Standard & Poor's, to a notch above junk status, had "caused a ratings
event related to a $690 million note payable that, absent Enron posting
collateral, will become a demand obligation on November 27, 2001."
In nonfinance jargon, it meant Enron was toast. Unless the company
could come up with $690 million, in cash, by November 27, the owner
of the promissory note (Enron never said who it was) could come in
and start seizing and selling Enron's assets.
Just below that note was another bit of information that surely had
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Richard Grubman smiling. During the October 2.3 conference call with
analysts, Grubman had asked Ken Lay about the health of Marlin, the
off-the-balance-sheet entity Enron used to hide debts it incurred while
setting up its misbegotten water venture, Azurix, and Lay had insisted
that everything involving Marlin was just dandy. But in its November
19 filing, Enron acknowledged that if the company's debt was downgraded to junk and its stock price was below an unspecified price,
Enron would have to "repay, refinance or cash collateralize additional
facilities totaling $3.9 billion." Of that amount, nearly one-fourth was
due to debt from Marlin.
Rebecca Mark's ghosts of bad water deals past were coming back at
the absolute worst time for Enron.
The November 19 filing stunned Chuck Watson and his team at
Dynegy. They'd been working night and day for two weeks to put the
merger together, and now Enron was saying that it had billions of dollars in additional debts that would have to be covered in cash if it
was to stay solvent. Watson phoned Lay to complain about the lack of
disclosure, and already anticipating legal action, he followed it up with
a letter. "We have not been consulted in a timely manner regarding
developments since November 9," wrote Watson. "We were not briefed
in advance on the issues in your lo-Q. Our team had to make repeated
phone calls to your finance and accounting officials in an attempt to
obtain information. Some of the most significant information in the Q
was never shown to us at all."1
A source close to the Dynegy team said the merger was hampered
from the beginning because Lay's team was continually changing its
story. "It was clear that the Enron negotiators didn't have a clue. They
didn't know how the business was going to run. They also didn't know
what would happen if the deal didn't go through." Furthermore, said the
source, "Lay didn't have a clue. He was like a deer in the headlights."
The Enron teamwhich consisted mainly of Lay; Enron's new
president, Greg Whalley; new vice chairman, Mark Frevert; and new
treasurer, Jeff McMahondidn't have a Plan B. If the Dynegy merger
failed, Enron would have to go into bankruptcy. And yet, despite their
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credit. In all, Enron borrowed about $5.5 billion in cash to keep its
doors open.
It wasn't nearly enough. The situation was simple: Enron was being
held hostage by the cash needs of its trading business. Enron barely discussed the problem in its November 19 filing, saying only that it was
using cash to provide "collateral deposits to trading partners."
Enron's counterparties were invoking the material adverse change
clause against Enron. The message was simple: Enron's worsening
credit situation was a material change in the company's financial situation. Therefore, Enron had to cover its trading positions with cash or
the counterparties would tell the world that Enron was no longer creditworthy, and that would create an even bigger run on Enron's treasury.
The material adverse clause, instead of saving Enron from a catastrophe, was accelerating the company's cash crisis. The lack of federal regulation of derivatives contractsthe exemptions engineered by Senator
and Mrs. Phil Gramm, regulations that might have forced Enron and its
trading partners to have proper collateralization in the first placewas
being played out. As Randall Dodd of the Derivatives Study Center
explained, "Enron had to come up with a whole lot more capital at a
time when it was capital short."
According to Enron's November 19 filing, it had $18.7 billion in liabilities from derivatives and commodities futures contracts on its
books. Nearly all of those positions were going to have to be collateralized. To do it, Enron needed many billions of dollars in cash it didn't
have and couldn't borrow.
It was deja vu all over again.
Ken Lay had nearly lost Enron to the trading disaster caused by
Enron Oil in Valhalla, New York, in 1987. Back then, Lou Borget and
his traders had gotten in over their heads. Borget's team had piled
losses on top of losses until they were faced with a position in the oil
futures market that totaled about $1.5 billion. Enron would have gone
bankrupt had its counterparties required the company to collateralize
all of its positions with cash. Enron only escaped that mess because
Enron executive Mike Muckleroy and his team of traders were able to
333
bluff the market and unwind Borget's positions. Those trading losses
forced Enron to take an $85-million charge against earnings in the
third quarter of 1987, and a chastened Ken Lay christened the mishap
an "expensive embarrassment."
Now, a shade more than fourteen years later, Lay had been snookered again. But instead of a $i.5-billion problem, Enron's vaunted trading business had more than $18 billion in liabilities. And there was no
one like Muckleroy to the ride to the rescue.
In 1987, Lay blamed the problems at Enron Oil on Borget and his
rogue traders, even though he and the other top executives at Enron
had been warned several times in the preceding months that Borget had
falsified records. Fourteen years later, Lay and Enron were being stung
repeatedly by disclosures about Fastow's self-serving scams, deals that
Lay and the Enron Board of Directors had blithely approved.
But none of it was Ken Lay's fault. Of course not. Someone else was
to blame. During a November iz conference call with analysts, Lay
pointed the finger at others. Referring to Fastow, Kopper, and their
cohorts, Lay said, "I'm sorry those six people seem to have gone somewhat over the edge in their dealings or transactions, but you can't be
absolutely protected from that in any business."
The delicate executive wouldn't need to be protected much longer.
The end was fast approaching.
As Enron's stock price spiraled downward, nearly every one of
Enron's trading parties was demanding that the company collateralize
its positions. The finance team was scrambling to find cash everywhere
it could, while trying to avoid doing anything that might spook the
credit rating agencies. Sure, the cash outflows were hurting the company, but a downgrade meant death.
The Downgrade
The days after Enron's November 19 restatement were chaotic. The top executives from
Enron and Dynegy had to convince the credit
rating agencies that the merger was going to
work. If they could do that, they could prevent the agencies from
downgrading Enron again. But with each passing day, all of the agenciesStandard 8c Poor's, Moody's, and Fitchwere increasingly nervous. Billions of dollars were riding on their decision about the fate of
Enron's debt.
Moreover, the two sides had to figure out a new structure for the
merger. Enron's still-sliding stock price had changed all of the agencies'
assumptions. When the merger was announced on November 13,
Enron's stock was trading at $9.98. Ten days later, as the New York
Stock Exchange quit trading for the long holiday weekend, Enron's
shares were worth just $4.71. As the price kept sliding, Dynegy had to
continually recompute the value of Enron and make an appropriate
offer. That offer would then have to be approved by Enron's board. It
was a time-consuming and frustrating process.
In addition, Dynegy's lead executives and negotiators on the merger
deal, CEO Chuck Watson, president Steve Bergstrom, and chief finan-
THE DOWNGRADE
335
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have to tell the folks from Dynegy. Enron was just figuring it out a few
hours before they talked to the people at Dynegy. No one at Enron had
a full understanding of all the potential implications" of the company's
accounting problems.
Dynegy also had questions about the profitability of EnronOnline.
The Dynegy team had always assumed that Enron's on-line trading
operation was making money. However, as the Dynegy negotiators
began inspecting the business more closely, it became increasingly obvious to them that despite the enormous volumes that were being generated on the web site, Enron was actually losing money on its trading
business. And the plunge in Enron's stock price and potential credit
problems had driven away many, if not most, of the entities that were
used to trading on EnronOnline. That meant Enron was being forced to
offer higher prices for commodities than competing on-line marketplaces, a fact that was making the exchange lose even more money.
By the end of the holiday weekendNovember z6, a Mondayit
appeared the two sides had worked out another deal. The original
merger agreement had called for Enron shareholders to get 0.2685
shares of Dynegy stock, worth about $10.50, for each share of Enron
stock, an amount that valued all of Enron's stock at about $9 billion.
That offer was now far too generous. Enron's stock was no longer
worth $10. So Watson's team decided to offer no more than $6 per
share, or about $5 billion. From Enron's side of the table, that offer
looked good. Hell, any offer looked good. By the time the New York
Stock Exchange closed on the 26th, Enron's stock was trading for just
$4.01. If Enron's shareholders could get Dynegy shares worth $6, at
least they'd get something. There were a few other provisions, including
another cash infusion of $500 million by J.P. Morgan Chase and Citigroup to keep Enron afloat and an agreement by some of Enron's creditors to delay the repayment dates of certain Enron debts until after the
merger was completed.
The cash infusion was critical. And Enron had been appealing to
deep pockets all over the world in an effort to find the money it needed
to stay in business. While it was negotiating with Dynegy, Enron
THE DOWNGRADE
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The Bankruptcy
DECEMBER 3, 2001
Enron closing price: $0.40
Dynegy closing prica: $27.17
The meeting of the board of directors on Saturday, December i, was perfunctory. Everyone on the board knew what had to be done.
After a brief discussion, the group voted
unanimously on a motion to declare bankruptcy. A few hours later,
during the early morning hours of December 2, a group of lawyers
from the firm Weil, Gotshal & Manges submitted Enron's bankruptcy
filings to the Federal Bankruptcy Court in New York's Southern District. They did it via the court's web site. Enron, the company that had
hyped its ability to trade bandwidth, to use the Internet to access new
markets, to transform the world, had filed bankruptcy without using a
single sheet of paper.
Ken Lay made sure to keep blaming someone else. Along with the
bankruptcy papers, Enron filed a $io-billion lawsuit against Dynegy,
claiming breach of contract.
There was more foolishness. Even though Enron's trading business
had helped drive Enron into the ground, Ken Lay still believed in it.
Sure, Enron's reputation was forever tarnished, his employees' pension
funds had been decimated, and thousands of Enron employees were
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about to be fired. But Lay just knew that he had to preserve the company's trading business. So in the days leading up to the bankruptcy,
Lay's company quietly provided payments totaling $55.7 million to
about 500 employees. In exchange, the employees agreed to stay on at
Enron for ninety days.
Of course, the traders got the biggest bonuses. John Lavorato, the
head of Enron's trading business, got $5 millionthat was in addition
to more than $2.3 million Enron had paid him in salary and long-term
incentives. Louise Kitchen, the woman who had helped create
EnronOnline, got $z million. Jim Fallen, who had overseen the spectacular failure of broadband trading at Enron Broadband Services, got
$1.5 million. Paul Racicot, the trader and Enron Broadband employee
who had told me five months earlier that Enron could "intermediate"
any business it chose, got $400,000. Jeff McMahon, who had succeeded Andy Fastow as CFO, got $1.5 million. Several dozen others got
bonuses ranging from a few hundred thousand dollars to more than $1
million. John Arnold, a gas trader who reportedly helped make $700
million for Enron by trading gas on the West Coast, is said to have gotten total bonuses in 2001 of $8 million. When asked by a reporter
about the bonuses, Enron spokesman Mark Palmer (who got a bonus
of $200,000) explained they were paid to "protect and maintain the
value of the estate."
THE BANKRUPTCY
341
traded gas, power, crude oil, propane, and dozens of other commodities, sat at their desks and watched TV or read the paper.
Thousands of other employees weren't so lucky. Throughout the
morning, clumps of employees, several dozen at a time, gathered for
meetings with their supervisors. Many of the employees, concerned
about the bankruptcy, had already cleaned out their desks and taken
their personal effects home. The ax fell for some right away. Others
were told that their job status was uncertain. "They told us to check
our voice mail tomorrow," one employee, Sanjays Pathak, told me after
he came out of the building. "That's a hell of a thing: getting fired by
voice mail."
By noon, the line of cars making their way to the front of the Enron
building stretched for blocks, snaking out of Andrews Street and then
north, onto Smith Street. They moved forward slowly, one at a time,
hurried on by a gaggle of impatient cops from the Houston Police
Department. Two of the cops were on horseback. Each car would stop
for a few moments, to pick up dejected former Enron employees. Some
of the people carried boxes, which they hurriedly loaded into the waiting car, driven by a friend, relative, or spouse. The cops weren't helping
matters. They even gave a few parking tickets to Enron employees
who'd just been fired.
Yuri Solomon, a big man, was one of them. He was in no hurry. He
slowly crossed Andrews and was gradually heading north on the sidewalk toward Smith Street. Every few steps, he'd stop and look back at
the shiny, oval-shaped building, occasionally shaking his head. In his
left hand was a blue plastic sack carrying some of the knicknacks from
his desk. In his right hand, he carried a tennis-ball-sized conglomeration of rubber bands. He walked a few more steps, then paused again
to look at the half dozen TV trucks and the growing group of reporters
and media people in the small park directly across the street from the
entrance to Enron's main lobby.
After three years at Enron, Solomon was in no hurry to leave. A
technician in Enron Networks, the information technology arm of the
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"Salvation Armani"
inside.
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the Big Rich. There were also hoping to catch a glimpse of the new
store's owner, Linda Lay.
Jus' Stuff was the Lay family's equivalent of K-Mart's Blue Light
Special. The store was the family's way of selling off the accrued detritus of decades of conspicuous consumption, which included several
homes in Houston, four properties (one vacant lot and three homes, all
worth many millions of dollars) in Aspen, and a multimillion-dollar
vacation spot in Galveston. And while the store was drawing gawkers,
it was also drawing scorn. Wags were continually coming up with new
names for Jus' Stuff, the best of which was "Salvation Armani."
Indeed, if Marie Antoinette were having a garage sale, it would
probably look just like Jus' Stuff.
Oh sure, there were a few cheap items. A gold picture frame was
going for $35. Nearby was an item whose tagwritten in neat cursive
handsaid "Very Pretty Turned Wood Candlestick." They cost $175
for the pair. But the good stuff required a much bigger checkbook.
For instance, the "Very Old Mirror From France" on the wall near the
door was priced at $7,200. The "Antique Religious Italian Metal Altar
Candlesticks" were $1,400 for the pair. The "Vermont Target Rifle
German Silver Inlay & Patch," which was casually poking out of a big
wooden box along with another old rifle, was tagged at $2.5550. And of
course, no self-respecting millionaire could live without a pair of
antique fireguards to protect the fireplace. Jus' Stuff had a pair. The
old-looking wooden gewgaws had an oval wood-and-glass medallion
affixed near the top of a thinner-than-a-broomstick pole. The tag, written in green ink, proclaimed "PairAmazing Antique Fire Guards with
Original Needle Work. $5,000." Anything that had descriptors like
"antique" or "amazing" on the price tag usually cost several thousand
dollars.
Linda and Robin Lay were at the store on the afternoon of June 27,
working the phones, talking to coworkers, managing their fledgling
small business. It was kind of quaint, really. Here was Linda Lay, who
just four months earlier had embarrassed herself by going on national
television and announcing that the Lays had "nothing left" and were
"SALVATION ARMANI"
345
"fighting for liquidity" (read: Poor people go broke, rich people fight
for liquidity). During her weepy interview on NBC's Today show, she
insisted that Ken Lay was a wonderful guy who "wasn't told" much
about the company's finances and that all the facts would come out
during the investigation.
Her appearance on NBC was an unqualified public relations disaster. Every commentator in the land mocked her for days afterward. But
here she was, stoically working at her store. Sure, she and Ken had
been humbled, but they weren't going to roll over and play dead, either.
But that didn't mean everyone in Houston was going to visit. "Several
Enron executives have told their wives not to even think of going into
that store," said one well-placed secretary who's still with the company.
Everything about Jus' Stuff horrified Houston's upper-crust social
set. One socialite expressed amazement at the fact that Ken Lay hadn't
left town, given the humiliation that came with Linda opening a place
like Jus' Stuff. In the span of one year, the Lays had gone from the city's
power couple to running a resale store. "I don't know how I could even
walk around in Houston if I were Ken Lay," said one well-known
socialite. "It'd be like carrying an elephant on my back. It's like she's
trying to shoot her husband in the foot."
For the first few weeks the shop was open, an off-duty officer from
the Houston Police Department secured the front of the building. The
Lays were expecting trouble. And they got a little bit. In early June, a
group of three or four dozen neighbors, activists, and artists had a bit
of fun at the Lay's expense. Led by Mark Larsen, a Houston-based
painter and performance artist, the group conducted a bit of performance art/protest/theater in the parking lot in front of the store. They
carried signs that read, "Imelda Marcos is Back" and "After This, Visit
The OJ. Simpson Flea Market."1
Larsen led the crowd in various chants, including one that went,
"We just want to say to you, we think your place smells like poo." The
group also did short skits. One skit involved a group of protesters/
artistes dressed in their finest furs and fashions for the event who began
chanting, "Let us shop. Let us shop."
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It was all in good sport, and the protesters had a grand time mugging for the TV cameras and making fun of the Lays. Alas, Linda Lay
was locked inside Jus' Stuff, well away from the none-too-respectful hoi
polloi out front. The store was unexpectedly closed, reported an
amused Wendy Grossman, a reporter for the Houston Press, "due to a
plumbing problem."2
Larsen, a native of Flint, Michigan, a Rust Belt city that has been
decimated by a corporate evacuation led by General Motors, told me
that he was motivated to organize the event because he felt that the
very existence of Jus' Stuff was "blasphemous." He said that other
Houston residents joined his protest for a simple reason: "They feel like
this country has been hijacked."
While Linda Lay works at Jus' Stuff, Ken Lay works at keeping out
of sight. He doesn't go out. He doesn't give speeches. He plays golf and
reads a bit. He still goes to the officenot at the Enron building, but at
a twelfth-floor corner suite of the River Oaks Bank Building. The sign
on his door says "Linda and Ken Lay Family." It's a convenient spot.
The office sits just a few hundred feet from the front door of the Huntingdon, the posh high-rise condo at 212.1 Kirby where the Lays occupy
the entire thirty-third floor. The Harris County Appraisal District values the condo, which has 12,827 square feet of living space, at $7.8
million. Their downstairs neighbor, by the way, whose condo is valued
at $1.2 million, is Lanna Pai, the ex-wife of Enron executive Lou Pai.
Indeed, the Lays looked to be prospering quite nicely, despite
Linda's statement in her January TV appearance that she and Ken had
"nothing left."
Linda Lay's idea of "nothing" is pretty hefty. County property
records show that she owns five properties in Houston, including two
single-family homes, two duplexes, and a triplex. Combined value of
those properties: $1.1 million. There's more. In addition to the condo
at the Huntingdon that the Lays own jointly, they own two other properties in Houston, a small apartment building and a single-family home.
They also own the retail building occupied by Jus' Stuff. All told, the
Lays' property holdings in Houston are worth more than $9.3 million.
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The Lays are clearly rich. But they won't be pardoned, not by the
city they used to dominate.
"Houston has had its share of crooks over the years. I don't know if
Lay was a thief or just a huckster," said John Mixon, a law professor at
the University of Houston who has observed the changing city since he
began teaching there in 1955. "But he violated the code by getting
caught and hung out to dry. He's made Houston look bad. And that
cannot be forgiven."
Elsewhere in the well-manicured confines of River Oaks, former
Enroners are living quite well, and all within two miles or so of each
other.
The Lays and the Fastows are the closest neighbors. The Fastows'
almost-finished house on Del Monte is just three-tenths of a mile from
the Huntingdon. The house is nearly complete. All of the stonework on
the exterior has been finished and workmen are busily painting the
interior. Andy Fastow, like his former boss, is keeping a low profile.
He's still going to his children's baseball games, but that's about the
only time he's seen in public. While they wait for the Del Monte house
to be finished, Andy, Lea, and their children stay in their huge house in
the Southampton neighborhood. A six-foot-wide American flag continues to hang from the second-story porch.
If his legal maneuvers are any indication of his mindset, Andy Fastow is also increasingly worried about his exposure to lawsuits and
criminal indictments. In June, Fastow's lawyer asked a federal judge in
Houston to rule that Fastow does not have to give depositions or produce documents for plaintiffs who are suing him in civil lawsuits. Fastow's reasoning is that any information he provides to the plaintiffs
could be used against him by prosecutors if (or when) he is indicted by
federal authorities.
Jeff Skilling lives in a $4.2-million Mediterranean-style mansion
with 8,100 square feet of living space and three fireplaces. It sits just
seven-tenths of a mile from Fastow's new house on Del Monte. Skilling,
too, is keeping an ultra-low profile, and he's fortifying his redoubt. In
"SALVATION ARMANI"
349
350
PIPE DREAMS
is likely to last for years, maybe decades. They might lose every one of
the lawsuits now facing them. But they don't have to worry. They live
in Texas. No matter what happens in court, they're still gonna be rich.
The Lone Star State has one of the most lenient bankruptcy laws in
America. In Texas, bankruptcy is no cause for shame, it's a tradition.
It's also no cause for losing your hard-stolen loot.
If Ken Lay or Jeff Skilling lose a few lawsuits, they could simply
declare bankruptcy. By doing so, they'd be allowed to keep a pair of
donkeys, 2.00 acres of ranchland, two firearms, and their homesteads.
And in Texas, that homestead can be a mega-mansion. It doesn't matter
if the house is worth $10,000 or $7.8 million, it's beyond the reach of
any creditors. So are luxury cars, salaries, and any retirement income.4
In most states, people who take bankruptcy are allowed to keep an
average of about $60,000 in home equity. There is no limit on home
equity in Texas. However, several bills now pending in Congress would
revamp the federal bankruptcy rules, which would cap homestead
equity exemptions at $125,000.5
Texas law also prevents creditors from seizing income the Lays are
likely to get from their annuities. In 2.001, Enron purchased two annuity contracts, with a total value of $10 million, for Ken Lay.6 One of
those annuities, a $4.7-million contract, will pay Ken and Linda Lay
$400,000 annually, starting in 2007.
So what about Rich Kinder? Oh, don't worry about him. He's not a
defendant in any of the Enron lawsuits. And he won't be taking bankruptcy anytime soon.
After Ken Lay refused to name him as Enron's CEO in 1996, Kinder
didn't get mad. He got even. In January 1997, he teamed with another
University of Missouri alum, Bill Morgan, and paid $40 million for one
of Enron's natural gas liquids pipelines. Enron thought the pipeline
wasn't profitable enough to keep. Kinder and Morgan did and built an
empire.
The two men did it in what Oil Patch guys call "midstream assets,"
"SALVATION ARMANI"
351
which means all the pipelines, tanks, and bulk terminals needed to
transport and refine oil and natural gas on its journey from the wellhead to consumers. By zooz, the companies they started, Kinder Morgan Inc. and Kinder Morgan Energy Partners L.P., had become
monsters of the midstream. The two interconnected companies own
and operate 25,000 miles of pipelines and over 70 terminals. Their
combined market capitalization is about $10 billion.
Kinder did it by being the anti-Skilling. Kinder Morgan doesn't do
any trading. Instead, it focuses on old-fashioned Big Iron and cash flow.
In interviews for TV and print outlets, Kinder has said several times
that he doesn't care about the price of oil or natural gas. "Everything
we do, we get paid a fee for service," Kinder told one reporter in zooi
(Kinder refused interview requests for this book). "The strategy is simple: we move as much product as possible and we try to grow the
throughput." Also, Kinder knows all of the risks that come with the
business. All of the company's assets are right here in the United States.
Buy them, then sit back and collect the fees they generate. There's no
commodity risk, no currency risk, no political risk, and no price risk. If
there's a dispute and a customer doesn't like your price, let them ship it
by truck.
The business structure is stupid simple. Kinder Morgan uses a master limited partnership that is Big Oil's equivalent of a real estate investment trust, or REIT. Partnerships like Kinder Morgan have a significant
tax advantage over corporations: They are exempt from corporate
income taxes as long as they distribute almost all their profits to
investors. Those reliable cash distributions allow the company to pay
unit holders a hefty dividend Kinder Morgan Energy Partners was
paying over 7 percent in late June which makes the equity attractive
to institutional investors looking for steady returns.
It's been a remarkably successful strategy, one that's been copied by El
Paso, Williams, and Dynegy, all of which have created their own publicly
traded limited partnerships in recent years. But Kinder Morgan remains
the king of the hill. Selected as the Houston Chronicle's company of the
year in May 2002, Kinder Morgan is the biggest master limited partner-
352
PIPE DREAMS
"SALVATION ARMANI"
353
green grass almost directly across the street from the front entrance of
one of Houston's most famous homes, Bayou Bend. The fourteen-acre
gardens and house located in a sweeping bend in Buffalo Bayou were
owned by oil heiress Ima Hogg (yes, Ima Hogg). She was the daughter
of Big Jim Hogg, the first Texas-born governor of the Lone Star State.
(The governor earned his nickname honestly. One Texas writer, O.
Henry, reported that Hogg was "about the size of two butchers.") Miss
Ima never married and became a notable collector of rare early American furniture and art. In 1957, she donated Bayou Bend, now a tourist
attraction, to the Houston Museum of Fine Arts.
While Kinder and Kinder Morgan sailed through the Wall Street
meltdown with nary a complaint, Houston's other energy giants have
been afflicted with serious cases of Enronitis. In March 2001, El Paso, a
giant natural gas company that, like Enron, jumped into the electricity
generation and energy trading markets, had a market capitalization of
$34.2. billion. By the end of June 2002., its market capitalization was
just $n billion. Dynegy, another resident of Houston's Energy Alley
that copied Enron's moves into trading and broadband, was worth
$15.6 billion in early zooi. By June 2,002., the company was being
investigated by the Securities and Exchange Commission for allegations
of financial wrongdoing and was worth just $2.76 billion. Williams
Companies, the Tulsa-based company that convinced Enron to get into
the broadband game, had been worth $20.4 billion. By the end of June
2002, it was worth $3.68 billion.
The collapse of Enron took a big human toll, too. On June 2, 2002,
El Paso's treasurer, Charles Rice, committed suicide. His death followed
the suicide of Enron's Cliff Baxter in January. At Dynegy, the company's founder and CEO, Chuck Watson, the man who believed he
could take over Enron, was forced out of the company in May. He was
followed a few weeks later by the company's CFO, Rob Doty, who quit
about the same time that Dynegy announced it was laying off several
hundred workers. El Paso, Dynegy, and Williams are all undergoing
huge restructuring plans. All are planning to sell assets and drastically
cut the amount of resources they allocate to trading.
354
PIPE DREAMS
Of course, these companies aren't alone. The implosions of WorldCom, Tyco, and other companies are symptomatic of the system that
allowed Enron to happen. That system is seriously broken and needs
immediate reform.
"SALVATION ARMANI"
355
3S6
PIPE DREAMS
"SALVATION ARMANI"
357
358
PIPE DREAMS
"SALVATION ARMANI"
359
360
PIPE DREAMS
"SALVATION ARMANI"
361
a bit overwhelming. But Sherri said, "I think it's a great place to get
started to learn about the hospital." And her new job has life insurance
and top-notch health coverage. "Since I'm the sole support for Bill and
[me], I just had to have those benefits."
She'd only been on the job since May 28, so she didn't want me to
come visit her at work. She didn't want to create the wrong impression,
or at least not appear conspicuous so quickly after being hired. So we
talked over the phone several times and traded gossip about Enron.
She and Bill were still living in the same $i,zoo-a-month, two-bedroom apartment. It's in West Houston in a quiet neighborhood. It has
1,250 square feet of living space. "Probably about the size of Ken Lay's
bathroom," Sherri said with a laugh. She and Bill are trying to be
upbeat. Their life savings are nearly gone, and Sherri knows she'll probably never have enough money to retire. She'll just have to keep working, probably for the rest of her life. She and Bill still want to do a bit
of traveling. But as the newest hire in her department, Sherri knows
there won't be any long vacations anytime soon.
Sherri had been reading the papers, of course, following all the latest news. She hadn't been to Jus' Stuff but wanted to know all the
details about the shop. When I mentioned I'd driven by Rebecca Mark's
house in River Oaks, Sherri lamented that she wished she'd bought
stock in Kinder Morgan instead of Azurix. But for some reason, she
and Bill had invested $2,000 in Azurix. Why? "Because Rebecca Mark
was the golden child. She spent hundreds of thousands of dollars on
whatever she wanted. So when she started Azurix, a lot of employees
jumped on that bandwagon." Sherri had bought the hype.
She was mad but not bitterabout her life post-Enron. She'd
always worked, and now she was just working somewhere besides
Enron. "Opportunities abound," at the medical center, she said. "People are always leaving. Jobs are up for bid and I'll be looking. It's a
great place to learn."
As for her pay, Sherri says the new job pays her $36,000. "I was making $46,000 to $48,000 at Enron, and more than that when you count
bonus and overtime," she said. "But you know, you can't get greedy."
Aftermath
SEPTEMBER s, 2003
ENRON CLOSING PRICE: $0.05
DTNEGT CLOSING PRICE: $3.87
364
PIPE DREAMS
AFTERMATH
365
366
PIPE DREAMS
AFTERMATH
367
Players Update
Everyone at Enron knew Andy Fastow was greedy. But no one knew
exactly how greedy he was until his indictment, issued by the Department of Justice, was made public on April 30, 2003. According to the
indictment, Andy Fastow and his wife, Lea, made $2.1 million in 1998.
The next year, the couple's income was $9.1 million. In 2000, their
income reached the astonishing sum of $48.5 million. But somehow,
even $48 million wasn't quite enough for the high-living Fastows. The
indictment also charges that the couple filed fraudulent income tax
returns for each of those three years.
In all, Andy Fastow faces eighty federal counts, including wire
fraud, securities fraud, mail fraud, money laundering, and conspiracy
to commit wire fraud. If convicted on the charges, he faces over 100
years in prison. His wife, Lea, is in similar trouble. In addition to the
fraudulent income tax charge, Lea Fastow was indicted for alleged
money laundering and conspiracy to commit wire fraud.
The indictments against the Fastows were part of a highly publicized spate of indictments made public in late April. Other former
Enron Big Shots who were indicted include former Enron Broadband
Services CEO Ken Rice and another former CEO of the broadband
unit, Joseph Hirko. In addition, the unit's former COO, Kevin Hannon,
was indicted along with former senior vice presidents Scott Yeager and
Rex Shelby and former EBS executives Kevin Howard and Michael
Krautz.
While the Enron Broadband guys were doing "perp walks" in front
of the TV cameras, other notable Enron refugees have been remarkably
quiet. Indeed, Lou Pai and Thomas White, the former bosses of Enron
Energy Services, as well as Rebecca Mark, the deal diva at Enron International and Azurix whose bad bets cost Enron at least $2 billion, have
been nearly invisible.
There was a bit of news on Pai in February 2003. That's when the
Senate Finance Committee released a report on the Enron scandal stating that Pai, the math whiz and stripper aficionado, hadin addition
to his salary and stock sales of more than $270 millionbeen given a
368
PIPE DREAMS
AFTERMATH
369
Watkins (along with Cynthia Cooper of WorldCom and Colleen Rowley of the FBI) "Whistleblower of the Year." The three women had their
pictures on the cover of Time and were feted for what the magazine
called their "ordinary demeanor but exceptional guts and sense."11 The
exposure has been lucrative for Watkins. By mid-2003, Watkins was
telling reporters that she was being paid $20,000 to $25,000 per speech
and that she was doing two speeches per month.12
The book that Watkins wrote with journalist Mimi Swartz, Power
Failure, appeared to be selling well, though it arrived in bookstores on
the eve of the U.S. war in Iraq and probably didn't get the attention its
publishers had hoped for. In addition to her speaking fees, Watkins was
formalizing plans to go into the consulting business, advising corporations on board functions and ethics. And while Watkins has become a
media darling, she has some detractors. In an op-ed in the Washington
Times, Charles Ganske of the conservative American Freedom Center
in Austin wrote that Watkins "blew the whistle in a soundproof room.
She never aired the concerns she expressed in her memo and conversation with Mr. Lay to regulators, the press, or the company's board, all
of whom she could have contacted anonymously." He continued, "a
true whistleblower would not have participated in fraudulent transactions, remained silent after Mr. Lay failed to act, and cashed in by selling her own Enron stock while armed with inside information."13
Meanwhile, Ken and Linda Lay are still living in the lap of luxury in
their posh condo at the Huntingdon. They have, however, quit the
Aspen scene. In late 2002 and early 2003, the Lays sold all four of their
properties in the Colorado resort town, for a total of $22.6 million.
Alas, they took a loss on the properties of about $1 million.14
While the Lays have become social lepers in Houston, Nancy and
Rich Kinder continue to do very well, thank you very much. On July
19, 2003, Nancy Kinder was one of the lead organizers of a fund-raiser
at Houston's Westin Galleria Hotel for George W. Bush's 2004 re-election campaign. About 1,500 members of Houston's smart set paid
$2,000 apiece to hear Bush's stump speech. (He didn't mention Enron.)
By the time of the fund-raiser, the Kinders' enormous new house on
370
PIPE DREAMS
Lazy Lane was nearing completion and Kinder Morgan's pipelines continued to be enormously profitable. After George W. Bush's tax cut
plan was passed by Congress, Kinder Morgan announced that it would
increase the dividend payments to its unitholders. That meant that in
2003, the Kinders would receive about $35.2 million in cash dividends.
And yet, thanks to the Bush tax cut, they would pay a mere 15 percent
of that income in taxes.15 By comparison, the wealthiest people in
America faced marginal income tax rates in 2003 of 37.6 percent. Even
middle class taxpayers earning $90,000 or so per year were paying
taxes at rates that were about two times the rate paid by the Kinders.
All of which proves that the rich really are different from the rest of us:
They pay less taxes.
Legislation/Reform Update
One of the most remarkable documents to come out of the postEnron era was produced on September 18, 2002. On that day, some of
the most powerful regulators in the Bush administration sent a letter to
U.S. Senators Zell Miller and Michael Crapo to express their opposition to regulation of financial derivatives. In their letter, the regulatorsFederal Reserve Chairman Alan Greenspan, Treasury Secretary
Paul O'Neill, Securities and Exchange Commission Chairman Harvey
Pitt, and Commodity Futures Trading Commission Chairman James
Newsomeinsisted that derivatives did not need to be regulated
because they have "been a major contributor to our economy's ability
to respond to the stresses and challenges of the last two years." A thenpending Senate proposal to regulate derivatives, they warned, could
increase "the vulnerability of our economy to potential future stresses."
Greenspan and his pals apparently decided to overlook the role that
over-the-counter financial derivatives played in the Enron bankruptcy.
But some of America's biggest investors think the chairman of the Fed
is making a big mistake. In March 2003, the world's smartest capitalist,
Warren Buffett, weighed in on the derivatives question. In his annual
epistle to Berskhire Hathaway shareholders he warned about the dangers of derivatives and pointed to the failures of Enron and Long-Term
AFTERMATH
371
372
PIPE DREAMS
The other key reform established since the failure of Enron is the
Sarbanes-Oxley Act. Passed by Congress, the measure requires a number of changes in corporate governance. It requires companies to set up
a confidential system through which employees can report malfeasance.
It requires a company's CEO and chief financial officer to swear to the
accuracy of their quarterly and annual financial reports. The law also
requires lawyers to notify the Securities and Exchange Commission if
they find material violation of financial rules and they cannot resolve
the matter with the company for whom they are working.18
The requirements of Sarbanes-Oxley, combined with more aggressive prosecutions by the Securities and Exchange Commission, should
stem the flood of corporate shenanigans for the next few years. But the
new regulations and new policing will not protect investors forever.
Crooks will always be able to find a way to cheat the system and steal
from investors.
Enron will happen again. It's only a matter of time.
The Bad
Jeffrey Skilling, president and CEO, Enron Corp. Prosecutors want to indict
Skilling in the worst way. But Enron insiders say prosecutors cannot find his signature on any of the key documents. Skilling is still living in his house in River Oaks.
A six-foot-high security fence and automatic gate surrounding the property were
completed in mid-2002.
The Worse
Andrew Fastow, chief financial officer, Enron Corp. Indicted. Facing about
eighty federal counts including securities fraud, conspiracy to commit wire fraud,
money laundering, insider trading, and filing false income tax returns. If convicted
on all counts, he faces over 100 years in prison. Federal authorities also want to
seize over $21 million in accounts owned by Andy and Lea Fastow as well as their
family home in the Southampton neighborhood. Trial will begin April 20, 2004.
Lea Fastow, wife of Andy Fastow and assistant treasurer, Enron Corp. Indicted.
Faces charges of conspiracy to commit wire fraud and money laundering, as well as
four counts of filing false income tax returns. Trial will begin February 10, 2004.
Ben Glisan, treasurer, Enron Corp. In prison. In September 2003, Glisan pled
guilty to a single count of conspiracy to commit wire and securities fraud and
began serving a five-year prison term. Glisan also agreed to forfeit more than
374
PIPE DREAMS
375
376
PIPE DREAMS
ing Enron in August 2000, the Deal Diva escaped at the right time. She's living
comfortably and quietly in River Oaks.
Lou Pai, CEO, Enron Energy Services. Pai continues to live the good life.
Although he sold $270 million worth of Enron stock, federal prosecutors appear to
be ignoring Pai.
Jeffrey McMahon, treasurer, Enron Corp. McMahon has been a target of prosecutors for months due to his participation in a scheme to sell some power plants
owned by Enron in Nigeria.
Richard Causey, chief accounting officer, Enron Corp. Causey's name was in the
Houston rumor mill throughout late 2002 and much of 2003, with the presumption that he could be indicted at any time. However, nothing has happened.
Thomas White, vice chairman, Enron Energy Services. Was named Secretary of
the Army by George W. Bush. In late April 2003, as the Second Iraq War was ending, Defense Secretary Donald Rumsfeld fired White.
Sources
Various Houston Chronicle stories; Department of Justice indictments; Ellen
Florian, "Scandal Cheat Sheet," Fortune, July 7, 2003, 48-49.
Kenneth N. Gilpin, "Ex-Treasurer of Enron Is Sentenced to 5 Years in Prison,"
New York Times, September 10, 2003.
Notes
378
NOTES
November 2001.
9. Fellows, Houston Natural Gas Corporation, 5.
10. Rebecca Busby, Natural Gas in Nontechnical Language (Tulsa, OK: PennWell Publishing, 1999), 7.
11. Ibid., 11.
iz. Fellows, Houston Natural Gas Corporation, 10.
13. Houston Metropolitan Study, The Houston Metropolitan Study: An Entrepreneurial Community Looks Ahead (Houston: Houston Metropolitan
Study, 1998), 23.
14. Fellows, Houston Natural Gas Corporation, 140.
15. Donna K.H. Walters, "Internorth Will Make $2.3-Billion Offer for Houston
Natural Gas," Los Angeles Times, May 3, 1985.
3: Buy or Be Bought
1. Bettijane Levine, "Feuding Families; Not Just the Sport of the Rich and
Famous, Infighting Is an Equal Opportunity Pastime," Dallas Morning
News, September 28, 1993.
2. Mark Ivey and John Rossant, "The Man Who Strikes Fear in the Heart of
the Oil Patch," Business Week, November 6, 1989.
3. Ibid.
5: The Lays Move to River Oaks
1. Sally Quinn, "Blond Bombshell from the Texas Boom Town," Washington
Post, December 17, 1978.
2. Ray Miller, Ray Miller's Houston (Austin, TX: Cordovan Press, 1982), 135.
3. Sandy Sheehy, "There Goes the Neighborhood," Forbes, October 26, 1992.
4. McComb, Houston: The Bayou City, 221.
5. Sheehy, "There Goes the Neighborhood."
6. Ibid.
6: The Valhalla Fiasco
1. Tricia Crisafulli, "Bulk Oil, Nichimen, Among Defendants in Enron Suit
Charging Fraudulent Trading," Platt's Oilgram News, June 16, 1988.
2. Ibid.
3. Peter H. Frank, "Enron to Close Unit After Costly Trades," New York
Times, October 23, 1987.
7: "The Smartest Son of a Bitch I've Ever Met"
1. Yergin, The Prize, 343.
2. Jeff Nesmith and Ralph K.M. Haurwitz, "Spills and Explosions Reveal Lax
Regulation of Powerful Industry," Austin American-Statesman, July 22,
2001.
3. Ken Lay, The Enron Story (New York: The Newcomen Society of the United
States, 1990).
4. Despite such regulation, many argue, rightly, that federal agencies have not
been vigilant in policing the pipeline industry on safety issues. Since 1990,
fires and explosions from pipelines have killed more than 200 people and
NOTES
5.
6.
7.
8.
379
injured more than 1,000 (Nesmith and Haurwitz, "Spills and Explosions
Reveal Lax Regulation of Powerful Industry"). However, the steady increase
in accidents has not persuaded federal regulators to step up their enforcement and inspection of interstate pipelines. And don't expect that to happen
during George W. Bush's administration.
Adam Levy, "Inside Enron: CEO Jeffrey Skilling Is Again Propelling the
Texas-Based Energy Company into a New Mix of Businesses," Bloomberg
Markets, May i, 2001.
Tom Skilling continued to pursue meteorology and is now chief meteorologist of WGN-TV in Chicago.
John Merwin, "We Don't Learn from Our Clients, We Learn from Each
Other," Forbes, October 19, 1987.
In 1990, Sawhill took over the leadership of The Nature Conservancy. He
died in 2000.
380
NOTES
NOTES
381
382
NOTES
20: Sexcapades
1. "Enron Payments to Insiders," published on Houston Chronicle web site.
Available: www.chron.com/enron, June 17, 2002.. The information in this
spreadsheet was culled from Enron's bankruptcy filings and lists payments to
144 Enron employees and contractors, including Travel Agency in the Park.
To access the file, go to the link on the right titled "Compensation to Enron
Executives."
21: The Family Lay
1. "Enron Payments to Insiders," Houston Chronicle.
2. Travel Agency in the Park has since changed its name to Alliance Worldwide.
3. David Barboza and Kurt Eichenwald, "Son and Sister of Enron Chief
Secured Deals," New York Times, February2,2002.
4. Ibid.
22:LJM1
1. This chapter relies heavily on the Powers report.
2. This information comes from the Powers Committee interview with Ken Lay.
Incredibly, Lay would later say he didn't understand what a special-purpose
entity was until October 2001.
3. This information conies from the Powers Committee interview with Vince
Kaminski.
23: Buying Off the Board
1. Roger Lowenstein, When Genius Failed (New York: Random House, 2000),
38.
24: The Deal Diva, or How to Lose a Couple of Billion Dollars and Still Be a Rock
Star
1.
2.
3.
4.
NOTES
383
384
NOTES
NOTES
3.
4.
5.
6.
385
quality and sustainability to manage and to boost its earnings. These transactions appear to be purposely obscured in Enron's public reporting." It should
also be mentioned here that on September 20, 2000, Wall Street Journal
reporter Jonathan Weil brought to light the dangers of mark-to-market
accounting. Weil, writing for the Texas Journal, a regional publication of the
Wall Street Journal, said that although companies like Enron and Dynegy
were booking big profits, what "investors may not realize is that much of
these companies' recent profits constitute unrealized, non-cash gains. Frequently, these profits depend on assumptions and estimates about future
market factors, the details of which the companies do not provide, and
which time may prove wrong." Weil's story was the first story by a major
business publication to underscore the risks that come with the mark-to-market method.
In late July 2002, the U.S. Senate began investigating Merrill Lynch's firing
of Olson. A spokesman for the giant brokerage firm insisted "Our research
was not compromised."
Bloomberg News, "Enron Enriched Wall Street Firms, Analysts Ignored
Warnings," December 18, 2001.
Charles L. Hill, "Statement of Charles L. Hill, Director of Research, Thomson Financial/First Call," U.S. Senate Government Affairs Committee, 107th
Cong., February 27, 2002.
"Enron Enriched Wall Street Firms, Analysts Ignored Warnings," Bloomberg
News, December 18, 2001.
386
NOTES
NOTES
387
2001.
388
NOTES
NOTES
389
Bibliography
Books
Busby, Rebecca. Natural Gas in Nontechnical Language. Tulsa, OK: PennWell
Publishing, 1999.
Dugger, Ronnie. The Politician: The Life and Times of Lyndon Johnson. New
York: W. W. Norton & Co., 1982.
Feagin, Joe R. Free Enterprise City: Houston in Political and Economic Perspective. New Brunswick, NJ: Rutgers University Press, 1988.
Fellows, Kenneth. Houston Natural Gas Corporation: Its First Fifty Years
1925-1975. Houston: Houston Natural Gas Corporation, 1976.
Fusaro, Peter. Energy Risk Management: Hedging Strategies and Instruments for
the International Energy Markets. New York: McGraw-Hill, 1998.
Houston Metropolitan Study. The Houston Metropolitan Study: An Entrepreneurial Community Looks Ahead. Houston: Houston Metropolitan Study, 1998.
Human Rights Watch. The Enron Corporation: Corporate Complicity in Human
Rights Violations. New York: Human Rights Watch, 1999.
Johnston, Marguerite. Houston: The Unknown City, 1836-1946. College Station:
Texas A&M University Press, 1991.
Lassell, Mary. John Henry Kirby, Prince of the Pines. Austin, TX: Encino Press,
1967.
Lay, Kenneth. The Enron Story. New York: The Newcomen Society of the United
States, 1990.
Lowenstein, Roger. When Genius Failed. New York: Random House, 2000.
McComb, David G. Houston: The Bayou City. Austin: University of Texas Press,
1969.
Mehta, Abhay. Power Play: A Study of the Enron Project. Mumbai, India: Orient
Longman, 1999.
Miller, Ray. Ray Miller's Houston. Austin, TX: Cordovan Press, 1982.
392
BIBLIOGRAPHY
BIBLIOGRAPHY
393
Index
396
INDEX
INDEX
Brown 6c Root, 77-78
Bruin Interests, 151-154
BT Alex. Brown Incorporated, 2.54
Buenos Aires project, 86, 183-185, 188
Buffett, Warren, 132, 212, 370-371
Burn rates, 176
Bush, Barbara, 91
Bush, George H. W., 80, 86-87, 91, 337
Bush, George W.
Enron connection, 85-92.
Kinder connection, 352, 3 69
lack of support for corporate reform,
35 6 > 357, 358
Lay connection, 3-4, 88-92,
270-274
OPIC influence, 109
twisting India's arm, 300-304
Bush, Jeb, 352
Bush Exploration Company, 8 5
Buy, Rick, 160, 163, 311, 358-359
Calhoun, Patrick, 18-19
California electricity crisis, 243-244,
270, 274
California Public Employees' Retirement System, 138-140, 354
Call options, 82-83
Campaign contributions, 87, 91,
107-108, 272
Carlyle Group Inc., 337
Caro, Robert, 77
Carter, Rebecca, 144-146, 321-322,
349
Cash flow
acceleration of, 3 04
analysts' ignoring problems with,
255-256
Azurix's failure, 175-178
boost from Chewco deal, 141, 143
debt downgrade, 3 29-3 31
Dynegy merger failure, 334-338
Enron Broadband as cash sinkhole,
285-288
Kinder's obsession with, 114, 351
LJM2 as cash generator, 223-231
Mark's ignorance of, 185-189
397
398
INDEX
INDEX
Deregulation. See Regulation and
deregulation
Derivatives, reform of, 370-371
Derivatives businesses, 5-6
ballooning growth of, 2.41-2.44
diversification into electricity, metals,
and e-commerce, 21 5-222
expansion through shell companies,
223-231
Gramm's regulatory bonus to Enron,
81-84
material adverse change clause,
219-221,331-332
need for structural reforms, 356
trading inside Enron, 158-159
Derrick, James, 298
Deshmukh, Vilasrao, 284
Dissertation, Lay's doctoral, 28
Dodd, Randall, 242, 332
Dodson, William, 140, 225, 228
Donaldson, Lufkin & Jenrette Securities
Corporation, 223-224, 254
Doonesbury, 343
Doty, Rob, 326, 335,353
Doubling down, 40
Douglas, William O., 236-237
Downgrade, of Enron stock to junk status, 334-338
Dresdner Kleinwort Wasserstein,
224
Drexel Burnham Lambert, 71-72
Dual-entry accounting, 61, 356-357
Dubose, Lou, 86
Dugger, Ronnie, 78
Duke Energy, 250
Duncan, David, 164, 238
Duncan, John, 188, 313-314, 318
Dunlap, "Chainsaw Al," 235
Dynegy Inc.
breach-of-contract suit against, 339
Enron-Dynegy merger, 326, 329-333,
334-338
mergers and acquisitions, 253
SEC investigation of, 353
sexual misconduct stance, 147
trading business, 250
399
400
INDEX
INDEX
Fortune maga21ne, 191-192., 151
Foy,Joe, 167
Freeport-McMoRan Copper & Gold,
107-108
French companies, 177-178
Frevert, Mark, 215-2.16, 315
Gagliardi, Lou, 2.49-2.51
Gandhi, Sonia, 301
Ganske, Charles, 369
Gas Bank, 51, 54-59, 196
Gaza Strip project, 109
General Accounting Office, 358
Gerstner, Louis Jr., 50
Glisan, Ben, 226, 227, 237, 329
Godbole, Madhav, 302
Goldman Sachs, 252, 253
Golfing junket, 261
Gonzalez, Arthur, 3 64
Goodyear, Charles, 108
Gorbachev, Mikhail, 3 24
Gore, Al, 108
Gramm, Phil, 368
Andersen connection, 238-239,
240-241
as link in the chain, xvi
CFTC exemption, 84
Thomas White and, 209
Gramm, Wendy Lee, xvi, 3 68
conflict of interest, 166, 240-241
pushing for Enron exemption, 81-84
resignation from Enron board, 3 59
Grasberg mine, 107
Gray, Rod, 188
Greenmail, 24-26, 33
Greenspan, Alan, 212, 324-327, 355,
370
Grossman, Wendy, 346
Grubman, Richard, 268-269, 317, 330
Gude, Alberto, 112, 183-185
Halliburton, 77, no, 235
Hanks, Stan, 192
Hannon, Kevin, 3 67
arrogance over Enron Broadband, 197
as Fastow's role model, 203
401
402
INDEX
INDEX
Fastow connection, 310
overstating profits, 32.8
profiting from LJM, 2x5-2x7
KPMG accounting firm, 2.33
Krautz, Michael, 367
Kroll Zolfo Cooper, 364, 365
Ku Klux Klan (KKK), 20
Kulpecz, Alex, 188
Kuwait, 80-81
Lanier, Bob, 4
Larsen, Mark, 345-346
Latiolais, Rene, 108
Lavorato, John, 217, 340
Lay, Bonnie, 27
Lay, Elizabeth, 30
Lay, Judie, 28, 29, 30
Lay, Ken, xi-xii, 3 69
Azurix, 175-178, 188
background and history, 26-30
Bush connections, 3-4, 86-88
California energy crisis, 271
character assassination by peers,
11-12
Congressional hearings, 358-359
covering up Whitewing, Osprey, and
Marlin disasters, 316-317
Enron board of directors, 161
Enron Prize, 323-327
Enron support of Lay family,
149-154
failing Sarofim's smell test, 268
finger pointing, 3 3 3, 339-340
hiding assets in LJM1, 156-157
implosion of Dynegy-Enron merger,
334-338
InterNorth-HNM merger, 31-3 3
Kinder and, 114
Kinder-McNeil affair, 117-119
moving to River Oaks, 34-36
on Enron Broadband, 276, 277-278
on Wessex Water acquisition, 179
overuse of private jets, 258-260,
265-266
post-bankruptcy behavior, 346, 369
Raptor meltdown, 309-310
403
INDEX
404
Lobbyists, 76
Char Is Walker, 89-90
fighting Leavitt's accounting reforms,
238-239
London Metal Exchange, 286
Long, Susan (Mrs. Jeff Skilling), 49
Long-Term Capital Management, 6,
166-167, 320, 324-3x6, 370-371
Loyalty, Skilling's scorn for, 123-1x5
Lucas, Anthony R, 17
Lumber industry, 17-20
Mahonia, 289-290, 355
Management style
Kinder's structured system, 111-115,
116-117
Lay's inability to fire employees, 30,
39-40
Mandela, Nelson, 323
Mansfield Dam, 77
Mark, Rebecca, xi-xii, 75, 361, 367,
368
ambition and ostentation, 170-174
Azurix's failure, 175-178
background and history, 93-98
Dabhol power plant, 98-103
Enron board of directors, 161
hostility to Skilling, 137
overuse of company jets, 262
post-bankruptcy status, 349
water conference, 169-170
Wessex Water acquisition, 178-181
See also Azurix
Mark, Thomas, 97
Mark-to-market accounting, 60-68
accounting reform, 356-357
Blockbuster-Enron deal, 282-283
cash flow issues in the trading sector,
2ZO-222
INDEX
Miller, Ray, 3 5
Miller, Zell, 3 70
Mintz, Jordan, 226
Minute Maid Park (formerly Astros
Field), 359
Mishra, Brajesh, 303
Mitchell, George, 352
Mixon, John, 348
Moffett, Jim Bob, 107-108
Moncrief, W.A., 44
Moody's Investors Services, 312, 3 20,
334
Moran, Mike, 114
Mordaunt, Kristina, 227, 329
Morgan, Bill, 350-353
Morgan Chase, 5
conflict of interest, 3 54-3 5 5
Dynegy-Enron merger negotiations,
335,336
Enron debt to, 255, 331
LJM2, 224
Mahonia deal, 289-290
Mosbacher, Robert, 79
Motorcycles, Ken Rice's fascination
with, 194-195
Muckleroy, Mike, 32, 38-39, 40-43,
116,332-333
Munger, Charlie, 371
Muniz, Vic, 306
Munoz, George, 108
Myhrvold, Nathan, 265
National Energy Policy Development
Group, 273-274
National Security Council, 300-301
National Tank Company, 164
NationsBanc Montgomery Securities
LLC, 253
Natural gas, 21-23
Bammel Field storage reservoir,
151-152
British use for electricity generation,
69-75
EnronOnline, 217-218
mark-to-market accounting on trading contracts, 65-66
405
406
INDEX
INDEX
"Recent Events" section, 329
Reform, need for, 354-358
Regulation and deregulation
derivatives regulation, 370-371
gas pipeline deregulation, 52-54
need for more regulation in corporate
structure, 354
Phil Gramm's Commodity Futures
Modernization Act, 240-241
price caps on California power, 271
Reagan's natural gas deregulation, 87
water industry, 180
Wendy Gramm's regulatory bonus to
Enron, 81-84
Republican National Convention,
87-88
Restatements, accounting, 234,
328-333
Revenue growth
under Kinder, 116
under Skilling, 138
versus cash flow, 60-68
Rhythms NetConnections, 155,
158-159, 227
Rice, Charles, 353
Rice, Ken, xi-xii, 3 67
affair with Amanda Martin,
145-146, 147
background and history, 195-198
Enron Broadband Services, 193-198,
245-248
NYPA deal, 65
post-bankruptcy status, 349
selling off stock and bailing out, 283,
291
sexual misconduct, 11
Skilling's promotion of, 137-138
trading, 123
Rice University, 323-324
Richards, Ann, 13, 88
Richardson, Sid, 44
Ridge, Tom, 91
Risk Assessment and Control (RAC),
130-131
River Oaks, 34-36, 173-174, 199-204,
352-353
407
408
INDEX
INDEX
Telecom industry. See Enron Broadband
Services
Telephone companies, 279-280
Tennessee Valley Authority, 273
Terragno, Rodolfo, 86
Texas City, 71
Texas Eastern Transmission Company,
77-78
Texas Gas Resources, 25
Thatcher, Margaret, 72
Thorn, Terry, 124
Tirello, Edward Jr., 191
Tompkins, Jack, 67
Tort reform, 88-89
Total return swap, 230-231
Trading business, 9-11
as new Enron vision, 215-222
collapse of other energy companies,
353
Kinder's refusal to engage in, 351
Lay's undying confidence in,
339-340
mergers and acquisitions,
252-253
need for derivatives reform, 356
Pai's skill at, 208-211
Performance Review Committee,
129-130
Skilling's Gas Bank and Enron
Finance, 54-59
Skilling's passion for, 46, 123-125
Valhalla trading and accounting
scam, 37-43
Transco Energy, 26, 29, 53
Transwestern Pipeline Company, 331
Travel Agency in the Park, 149
Travel expenses, 149-150
Twain, Mark, 181
UBS Warburg, 254, 255, 358, 368
Underwriting business, 252-253
Unemployment, 1-3
Unger, Laura, 358
United Gas Pipe Line, 53
United Kingdom, 178-185
United Media Corporation, 153
409
410
West, Jim, 36
Whalley, Greg, 215, 315
Whistle-blowing, Sherron Watkins's,
194-298
White, Thomas, 116, 209, 272, 367,
368
Whitewing, 156, 225, 290-291,
316-317
Williams, Clayton, 13
Williams Companies, 276-277, 353
Wilson, Woodrow, 19
WilTel, 276
Windfall-profits tax, 87
Wing, John, 32, 69-75, 97-98
Wing-Merrill Group, 80
Winokur, Herbert "Pug," 163-164,
INDEX